What is bankruptcy law?

Federal law, with some state rules

The Constitution gives Congress the power to pass “uniform laws on the subject of bankruptcies,” so bankruptcy is federal. Cases are filed in US bankruptcy courts, which are units of the federal district courts, and follow the Bankruptcy Code (Title 11 of the US Code) and the Federal Rules of Bankruptcy Procedure. State law still matters in two ways: it defines many property rights, and it supplies the exemptions that determine what property an individual debtor keeps, with some states allowing a choice of federal exemptions.

The two goals

Bankruptcy law balances a fresh start for honest debtors, freeing them from debts they cannot pay, with fair and orderly treatment of creditors, who are paid from available assets according to set priorities rather than in a race to the courthouse.

The main chapters

• Chapter 7 (liquidation) — a trustee sells non-exempt assets and distributes the proceeds; most unsecured debts are discharged. Used by most individual filers, subject to a means test.
• Chapter 13 (individual reorganization) — a three- to five-year repayment plan for individuals with regular income; often used to save a home from foreclosure.
• Chapter 11 (reorganization) — used mainly by businesses to restructure debts while continuing to operate, from small companies to major corporations such as airlines and retailers. Individuals with very large debts can use it too.
• Subchapter V of Chapter 11 — added in 2020 for small businesses, with faster, cheaper procedures and no creditor committee. Debt limits apply.
• Chapter 12 — for family farmers and fishermen with regular income.
• Chapter 9 — for municipalities, such as Detroit's 2013 case.
• Chapter 15 — for cross-border cases involving foreign proceedings.

Key concepts

• Automatic stay — filing immediately stops most collection actions, lawsuits, garnishments, repossessions and foreclosures.
• Bankruptcy estate — all the debtor's property at filing becomes part of an estate administered under court supervision.
• Exemptions — protect certain property, such as a home up to a limit, a car, household goods and retirement accounts.
• Trustee — a court-appointed official who administers Chapter 7, 12 and 13 cases; in Chapter 11, the business usually continues as “debtor in possession.”
• Discharge — a court order releasing the debtor from personal liability for covered debts.
• Priority and secured claims — secured creditors are paid from their collateral; priority claims such as support and certain taxes come before general unsecured claims.

Limits on the fresh start

Some debts survive bankruptcy, including child support and alimony, most student loans, most recent taxes, criminal fines and debts from fraud or drunk-driving injuries. Courts can deny a discharge altogether for hiding assets, lying under oath or destroying records, and bankruptcy fraud is a federal crime.

How common is it?

Several hundred thousand bankruptcy cases are filed in the United States each year, the vast majority by individuals under Chapters 7 and 13. Filings fell sharply during the pandemic and have been rising again since 2023.

Alternatives to bankruptcy

Debt settlement, credit counseling and debt management plans, loan modification, and negotiating directly with creditors can work for some people. For others, especially those facing garnishment, foreclosure or lawsuits, bankruptcy provides protection that no private arrangement can.

Getting help

Bankruptcy attorneys often offer free consultations and flat fees for consumer cases. Nonprofit credit counseling agencies approved by the US Trustee Program provide the mandatory pre-filing course and can discuss alternatives.

The people involved in a case

A consumer bankruptcy typically involves the debtor and their attorney, a trustee who reviews the case and, in Chapter 7, collects non-exempt property, the US Trustee (a Department of Justice office that oversees trustees and watches for abuse), creditors who may file claims or objections, and the bankruptcy judge, who decides disputes. In most consumer cases, the debtor never appears before the judge; the only required appearance is the meeting of creditors, often held by video.

The means test

Since the 2005 reform law (BAPCPA), individuals with primarily consumer debts who earn above their state's median income must pass a means test to use Chapter 7. Those who do not qualify can usually file under Chapter 13 instead.