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What Is Bankruptcy?

Brief Overview1
Bankruptcy law provides for the development of a plan that allows a debtor, who is
unable to pay his creditors, to resolve his debts through the division of his assets among his
creditors. This supervised division also allows the interests of all creditors to be treated with
some measure of equality. Certain bankruptcy proceedings allow a debtor to stay in business and
use revenue generated to resolve his or her debts. An additional purpose of bankruptcy law is to
allow certain debtors to free themselves (to be discharged) of the financial obligations they have
accumulated, after their assets are distributed, even if their debts have not been paid in full.
Bankruptcy law is federal statutory law contained in Title 11 of the United States Code.
Congress passed the Bankruptcy Code under its Constitutional grant of authority to “establish…
uniform laws on the subject of Bankruptcy throughout the United States.” See U.S. Constitution
Article I, Section 8.
States may not regulate bankruptcy though they may pass laws that govern other aspects
of the debtor-creditor relationship. A number of sections of Title 11 incorporate the debtorcreditor
law of the individual states.
Bankruptcy proceedings are supervised by and litigated in the United States Bankruptcy
Courts. These courts are a part of the District Courts of The United States. The United States
Trustees were established by Congress to handle many of the supervisory and administrative
duties of bankruptcy proceedings. Proceedings in bankruptcy courts are governed by the
Bankruptcy Rules which were promulgated by the Supreme Court under the authority of
There are two basic types of Bankruptcy proceedings. A filing under Chapter 7 is called
liquidation. It is the most common type of bankruptcy proceeding. Liquidation involves the
appointment of a trustee who collects the non-exempt property of the debtor, sells it and
distributes the proceeds to the creditors. Bankruptcy proceedings under Chapters 11, 12, and 13
involve the rehabilitation of the debtor to allow him or her to use future earnings to pay off
creditors. Under Chapter 7, 12, 13, and some 11 proceedings, a trustee is appointed to supervise
the assets of the debtor. A bankruptcy proceeding can either be entered into voluntarily by a
debtor or initiated by creditors. After a bankruptcy proceeding is filed, creditors, for the most
part, may not seek to collect their debts outside of the proceeding. The debtor is not allowed to
transfer property that has been declared part of the estate subject to proceedings. Furthermore,
certain pre-proceeding transfers of property, secured interests, and liens may be delayed or
invalidated. Various provisions of the Bankruptcy Code also establish the priority of creditors’
However, a recent decision by the Supreme Court has shifted this power towards the
debtor. In Rousey v. Jacoway, (April 4th, 2005), the Court held that assets in Individual
Retirement Accounts (IRA’s) are protected under 11 U.S.C A.§ 522(d) and thus exempt from
withdrawal from the bankruptcy estate. This decision has broad implications for the babyboomer
generation, providing millions of Americans nearing retirement with increased
protection of their earnings.
Recent passage of the Bankruptcy Prevention and Consumer Protection Act in April 2005
has also resulted in major reforms in bankruptcy law, outlining revised guidelines governing the
dismissal or responsibilities of the United States Trustees Program to include supervision of
random and targeted audits, certification of entities to provide credit counseling that individuals
must receive before filing for bankruptcy, certification of entities that provide financial
education to individuals before being discharged from debt, and greater oversight of small
business Chapter 11 reorganization cases.

1 This summary appears on the website prepared and maintained by Cornell University
Law School LII/Legal Information Institute at the following web address:
http://topics.law.cornell.edu/wex/bankruptcy 7/12/2008
Bankruptcy | LII / Legal Information Institute.