The U. S. Bankruptcy Code - An Overview

As with all legal issues, credit executives are urged to seek legal counsel if and when a customer files for bankruptcy protection.

The term bankruptcy comes from Latin and means “broken bench.”  Hundreds of years ago, when a merchant failed to repay suppliers in a timely manner, the suppliers would break the benches which displayed the goods of the merchant. With a broken bench, that merchant was unable to conduct business. Today, bankruptcy is far more complex.  In the United States, bankruptcy is governed by federal law.

The History of the Bankruptcy Code

The Bankruptcy Act is federal law that provides an organized procedure under the supervision of a federal court for dealing with insolvent debtors. It is found in Title 11 of the United States Code. The Bankruptcy Code was adopted in 1978 and became effective on October 1, 1979. The 1978 Code was the first substantial revision of the bankruptcy laws in effect in the United States. Prior to 1979, the Bankruptcy Act of 1898 (or the Bankruptcy Act) was in force. Although the 1898 Act allowed individual bankruptcy filings, it was primarily a business law for the winding up of failed businesses. In 1994, Congress made provisions for small business and single asset reorganizations. Since 1978, Congress also added Chapter 12 to deal with the farm crisis. Also in 1994, Congress increased the debt limits in Chapter 13.

The Code consists of eight chapters. The first three chapters, Chapters 1, 3, and 5, contain administrative provisions that apply in all cases under the Code. The remaining five chapters, Chapters 7, 9, 11, 12, and 13, are the operative chapters for filing different types of bankruptcies. Chapter 7 is a liquidation bankruptcy, sometimes called a straight bankruptcy, in which a trustee is appointed by the United States Trustee in every case to liquidate nonexempt assets. Chapter 9 pertains to municipalities and governmental units. A Chapter 9 bankruptcy can only be filed on a voluntary basis. Chapter 11 is the business reorganization. Most Chapter 11 bankruptcies involve a debtor in possession of assets who is attempting to reorganize or rehabilitate a business. A small business may reorganize under an expedited Chapter 11 proceeding. A small business is defined as a business with total debts of less than $2,000,000.

Chapter 12 is used only with a voluntary petition by family farmers who have debts not exceeding $1.5 million. The purpose of this chapter is to provide family farmers with a chance to reorganize debt and retain their land.

Chapter 13 is sometimes called the wage earner's plan. Individuals with wages or income are eligible to file under Chapter 13 as are certain professional or business owners. The current law establishes a threshold limit for a debtor to be eligible to file. This threshold is set at a level of secured debt of less than $750,000 and unsecured debt of less than $250,000.

One of the most important things to know about the Bankruptcy Code is that adherence to deadlines is critical; noncompliance can affect one’s rights under the law.

Edited by Michael C. Dennis.  Mr. Dennis is an author and consultant.