What Is Bankruptcy Court?
U.S. bankruptcy court refers to specialized federal courtrooms in the United States. The federal government created bankruptcy courts to settle all types of personal and corporate bankruptcy cases.
Unlike the federal court, which the U.S. Constitution established in 1781, the bankruptcy court system did not exist until 1978, when Congress established it as part of the Bankruptcy Reform Act. The U.S. Bankruptcy Code has been amended numerous times since then.
- Bankruptcy courts are part of the federal court system.
- There are 94 Federal bankruptcy courts in the United States, and bankruptcy court judges serve 14-year terms on the court bench.
- It is possible to end up in bankruptcy court if you can't afford to pay your debts, though you may not always need to liquidate all of your assets.
- Company owners sometimes file bankruptcy to reorganize their debts and financial obligations without losing their business.
- You may dispute the findings of the bankruptcy court.
How Bankruptcy Court Works
While most criminal, civil, and family cases are heard in state courts, bankruptcy must be filed in a federal court. The laws that govern bankruptcy are part of federal law, not state law, so in order to start bankruptcy proceedings, an individual must work within the federal court system.
There are 94 federal judicial districts throughout the United States, and each district has a bankruptcy court. Federal law requires that a bankruptcy case be filed and heard in the judicial district that is the site of the primary residence, place of business, or principal assets of the filer. Though the cases take place within individual states, the Federal Rules of Bankruptcy Procedure govern the bankruptcy process, in order to maintain consistency from state to state.
The United States Court of Appeals appoints bankruptcy judges, who serve 14-year terms. Proceedings of a bankruptcy court are public unless a judge rules that they remain under seal, and can be accessed at a bankruptcy clerk's office or through the Public Access to Court Electronic Records, also called PACER.
Procedures in Bankruptcy Court
Bankruptcy itself can occur when a person or business cannot repay their debts. Once the debtor files the petition, the following proceedings are decided by the bankruptcy courts: The court measures and evaluates the debtor's situation, and then returns a process and plan for how the debtor’s assets may be used to repay a portion of outstanding debt.
The decision is overseen by a bankruptcy judge, and that judge is able to decide whether or not the debtor should be discharged of their debts. This means that the debtor will no longer be responsible or personally liable for the debts associated with the filing. Some debts, however, are ineligible for discharge, including tax claims, child support, alimony payments, and personal injury debts. An individual also cannot be discharged from any debt on any secured property, and any creditor can still enforce a lien on a debtor’s property.
Bankruptcy courts make extensive use of video- and audio-conferencing facilities because it is impossible to assemble creditors from different parts of the country into a single room at the same time.
Types of Bankruptcy
Bankruptcy courts review a number of different bankruptcy cases. These cases range from companies to individuals, each with different strategies on how to make their creditors whole. Below are the most common types of bankruptcy types, with the name of each type acting as a referencing to the section of Title 11 the United States Code that governs the liquidation process.
- Chapter 7: Also known as a "liquidation" bankruptcy, Chapter 7 bankruptcy allows individuals or businesses to discharge most of their debts by liquidating non-exempt assets. The bankruptcy trustee sells off assets to pay creditors, and Chapter 7 is the most common form of bankruptcy for individuals.
- Chapter 11: Chapter 11 bankruptcy is typically used by businesses to reorganize their debts and continue operating while repaying creditors. It can also be used by individuals who have too much debt to qualify for Chapter 13. This is another common form of bankruptcy.
- Chapter 12: Chapter 12 bankruptcy is similar to Chapter 13, but it is specifically designed for family farmers and fishermen who have regular income.
- Chapter 13: Chapter 13 bankruptcy allows individuals to reorganize their debts and create a payment plan to repay creditors over three to five years. This approach is often used by companies or individuals that have high revenue or earnings and expect to be able to make creditors whole over time.
- Chapter 15: Chapter 15 bankruptcy is used in cases where the debtor has assets or debts in multiple countries. It is a way to coordinate different bankruptcy proceedings and ensure that all creditors are treated fairly regardless of jurisdiction.
Avoiding Bankruptcy Court
Debtors have some strong benefits to attempt to avoid filing for bankruptcy and avoiding bankruptcy court. Bankruptcy court is potentially expensive, with the debtor being responsible to pay for attorney fees, court costs, administration fees, filing charges, and a very wide range of miscellaneous fees.
Another large downside to bankruptcy court is a lack of privacy. By filing for bankruptcy, your financial situation becomes public record. Whether you are an individual not wanting sensitive information publicly known or a company not wanting its image tarnished, there are social aspects of bankruptcy court that simply can't be avoided.
Going to bankruptcy court has an impact on your credit score. Though this may already be a foregone conclusion if you are already past due on debts, filing for bankruptcy can significantly and negatively impact your credit score for years. It is possible to regain a strong credit score over time.
Last, when you file for bankruptcy, you do not have control over your assets. A trustee is often appointed to oversee your assets, and they may sell your assets as they see fit. By avoiding bankruptcy court, you may retain control over what you keep, what you sell, and what you sell certain assets for.
Can You Appeal a Bankruptcy Court Decision?
If an individual or creditor disagrees with the bankruptcy judge’s decision and wishes to contest the judge’s ruling, the filer has the option of filing an appeal and beginning the appeal process.
The appeal is generally made by individuals or businesses that have standing in the decision or are directly affected by it. A bankruptcy court decision incorporates multiple claims made by creditors, who can claim "financial injury," and are directly affected by it. The appeal, for example, may be the result of a creditor's claim not being honored or being disputed by the bankrupt business or individual.
The appeal must be filed within ten days of the bankruptcy court's decision. An appeal court generally handles bankruptcy appeals. In fact, there are many judicial circuits that have their own bankruptcy-specific appellate courts to handle such disputes.
Bankruptcy courts don't always approve the debtor's plans. Consider how the U.S. Court of Appeals rejected Johnson & Johnson's subsidiary's bankruptcy plan in January 2023.
Examples of Bankruptcy Court Cases
In November 2022, FTX Trading Ltd. and 101 of its affiliated companies collectively filed for bankruptcy. After raising $1.8 billion from investors, the cryptocurrency exchange was among the highest exchanges during the 2021 cryptocurrency boom. However, towards the end of 2022, FTX faced deficit of billions of dollars presumably led by a misappropriation of depositor funds.
FTX's case is being overseen by bankruptcy court to decide how to best allocate the minimal but remaining company assets. This may mean selling the assets or restructuring the organizational structure. In either situation, the company appears to be unable to make all creditors whole, thus the need for bankruptcy court intervention.
A comparable case was seen 15 years earlier when Lehman Brothers Holdings Inc. and 22 of its associated companies filed for bankruptcy. The company's Chapter 11 plans were reviewed and confirmed by the bankruptcy court, and the plan was made effective in 2012. The plan outlined various distributions, and annual plan trust distributions are still reported each year.
What Happens When Someone Declares Bankruptcy?
When someone files for bankruptcy, your debt is discharged. You may not longer be responsible for paying those debts, and your creditors can't contact you or attempt to collect on that debt. However, this often comes as a liquidation or restructuring of assets.
Does Bankruptcy Court Lead to Jail?
No, bankruptcy court is different from other forms of court. Bankruptcy court is focused on the plan and distribution of assets from a liquidation or restructuring plan following a bankruptcy filing. Though bankruptcy court does not handle criminal activity, you may still face repercussions from other courts as a result of a bankruptcy (i.e. misappropriating investor funds).
Does a Bankruptcy Court Get Rid of Everything?
A bankruptcy court often handles existing debts. However, they do not get rid of liens against assets. Should the debtor have a lien against property they still own and possess, bankruptcy courts will often handle the restructuring or liquidation of that asset to satisfy that lien. This often entails someone taking possession of that asset, selling it at an auction, then applying the financial proceeds to make the lienholder whole.
Is It Better to File for Bankruptcy or Do Nothing?
Every person or company's situation will be different. In general, if you still have burdensome or troublesome debt that will not be discharged post-bankruptcy, it may not make as much sense to file for bankruptcy. Bankruptcy also does not prevent a secured creditor from repossessing property; this outcome may ultimately need to happen regardless of other actions taken.
The Bottom Line
The 94 federal judicial bankruptcy courts help people who no longer can pay their credits. In most cases, these bankruptcy courts handle the liquidation or restructuring of assets to ensure proper creditors receive what they are appropriately due. Though bankruptcy court can't extinguish all debts, they are the governing body that oversees the plans to transition assets from the bankrupt entity to the appropriate creditors or individuals.