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Laws Governing Bankruptcy

Article I, Section 8, Clause 4 of the United States Constitution, gives Congress the power “to establish … uniform Laws on the subject of Bankruptcies throughout the United States.”  Prior to the current law governing bankruptcy, under The National Bankruptcy Act of 1898, debtors could liquidate nonexempt assets and return the proceeds to their creditors in exchange for a limited bankruptcy discharge. In 1938, Congress amended the 1898 Bankruptcy Act to add three corporate restricting chapters which became the precursors of Chapter 11 of the current bankruptcy Code. Later in 1978, Congress repealed the 1898 Bankruptcy Act and replaced it with the Bankruptcy Code which made changes to almost every aspect of bankruptcy law. Among the many changes, the act placed all of the debtor’s financial disputes in one court; the bankruptcy court, which a bankruptcy judge governed. The Bankruptcy Amendments and Federal Judgeship Act of 1984 “made the bankruptcy court a ‘unit’ of the district court and required that certain bankruptcy court decisions be reviewed by the district court prior to their becoming final.”

By 1995, Congress passed yet more amendments to the Bankruptcy Code in order to remedy the issues that arose from the bankruptcy courts interpreting the laws Congress had passed twenty years earlier. The credit industry made attempts to make it more difficult for consumer debtors to discharge their debt under Chapter 7 bankruptcy. They succeeded in 2005 when Congress passed the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005. One of the purposes of the law is to encourage consumer debtors to use the repayment plan under Chapter 13 bankruptcy more often. The 2005 act makes it much more difficult for certain consumers debtors to use chapter 7 liquidation bankruptcy. Among many changes to the Bankruptcy Code, chapter 7 now includes a means test. A means test permits the court to dismiss a case filed by an individual consumer debtor under chapter 7 bankruptcy or, “with the debtor’s consent, convert such a case to a case under chapter 11 or 13, if it finds that the granting of relief [under chapter 7 bankruptcy] would be an abuse of the provisions” under chapter 7 bankruptcy.

Today, the main body of law applied in bankruptcy courts is derived from Title 11 of the United States Code, which is also referred to as the Bankruptcy Code. In bankruptcy courts, procedure is governed by the Federal Rules of Bankruptcy Procedure and the Federal Rules of Evidence are applied. The majority of the Federal Rules of Bankruptcy adopt the Federal Rules of Civil Procedure.

However, in some instances, state law is also applicable.  Section 522 in Subchapter 2 in Chapter 5 of Federal Bankruptcy law lists the property that is exempt from liquidation.  Federal law allows for states to opt out of most of those exemptions and create their own exemptions, and most states do.  However, there are some exemptions included in 11 U.S.C. 522 which states cannot opt out of.

Chapter 7 of Title 11 governs liquidation of an individual’s assets.  Chapter 9 governs municipality bankruptcy and provides relief for municipalities in the form of reorganization of debt.  Chapter 11 governs reorganization of debts.  Chapter 11 is typically used by businesses rather than individuals, but Chapter 11 is available to individuals as well.  Chapter 13 governs debt adjustment for individual debtors.  Bankruptcy procedure is governed by the Federal Rules of Bankruptcy Procedure.  Each individual bankruptcy court has local rules that govern bankruptcy procedure as well.

When bankruptcy crimes are committed, Title 18 of the U.S. Code, which sets forth certain crimes, is the governing law. When there are bankruptcy crimes a bankruptcy court will use state and federal law to determine the rights of the parties involved in a bankruptcy case. State and federal laws are also used when bankruptcy cases involve other areas governed by state and federal law such as real estate, contract, tort, fraud, and tax law.

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