Bankruptcy: A Primer for Municipal Clerks

Municipal Law Alert, July 2011

With economic malaise continuing to grip the country, bankruptcy filings continue at record levels. Our firm continues to field numerous calls from municipal clerks wondering what to do when they receive the dreaded notice that someone who owes the municipality money has filed for bankruptcy protection. This article briefly describes the bankruptcy process and discusses some items clerks should consider when they receive notice of a bankruptcy filing.

  • What is Bankruptcy?

Bankruptcy is a specialized area of law, which is subject to complex rules and jargon that most find confusing. The Bankruptcy Code (the “Code”) creates uniform bankruptcy procedures for the entire country. Bankruptcy is a form of legal relief granted to people (called “debtors”) in appropriate cases by federal bankruptcy courts.Wisconsin has two bankruptcy courts: (1) the United States Bankruptcy Court for the Eastern District of Wisconsin; and (2) the United States Bankruptcy Court for the Western District of Wisconsin. In most cases, bankruptcy filings affecting debtors in Northwestern Wisconsin will be filed in the Western District of Wisconsin’s Eau Claire division. When the case is filed, all collection efforts against the debtor must stop or “stay”. This halting of collection is legally referred to as “the automatic stay,” which is discussed in some detail below. At the end of the case, in most instances, a debtor is granted a discharge, which prohibits existing creditors from making any attempt to collect from the discharged debtor. The goal is to give the filing debtor a “fresh start” from debts.

  • Who can File Bankruptcy?

Every person and legal entity has the ability to file for bankruptcy protection. Most individuals file for bankruptcy under either Chapter 7 or Chapter 13 of the Code. Most corporations and other legal entities file under Chapter 11 of the Code. Farmers can file under Chapter 12 of the Code. Under the Code (a federal law), municipalities can file for bankruptcy under Chapter 9 of the Code. However, in Wisconsin (under state law), local governments may not file for bankruptcy protection because they have never been granted bankruptcy authorization.

Chapter 7: Chapter 7 is often called the liquidation chapter because it provides for the sale of all of the debtor’s non-exempt assets in order to pay debts. However, the term “liquidation chapter” is often a misnomer because in most cases all of the debtor’s assets are exempt from sale. The Code and Wisconsin law provide these exemptions, and they include items like the homestead, vehicles, retirement accounts, and household furnishings. Each applicable exemption has a dollar limit. If the asset is worth more than the limit, the asset could be sold and the non-exempt portion could be used to pay creditors. However, that rarely happens, as most debtors are able to find an exemption for most of their assets. Higher wage earners are generally not able to file a Chapter 7 and must instead file a Chapter 13.

One issue for municipalities to be aware of in a Chapter 7 is the concept of reaffirmation of secured debts. If your municipality has loaned money to a debtor under a program to purchase or refurbish property and holds a mortgage as collateral, the debtor may desire to enter into a reaffirmation agreement with the municipality in order to keep the property. When a reaffirmation agreement is entered into, it simply means that particular debt is not discharged. For more information regarding Chapter 7, visit the U.S. Courts website by clicking here.

Chapter 13: Chapter 13 is the consumer bankruptcy alternative to Chapter 7. Instead of selling non-exempt assets, the debtor becomes subject to a payment plan. The payment plan requires the debtor to pay some or all of the debtor’s debts over the course of a 3-5 year period. If the plan is successfully completed (in other words, if the debtor makes all the payments required under the plan), the remainder of the debtor’s debts are discharged. The payment amount depends on the debtor’s disposable income. For more information regarding Chapter 13, visit the U.S. Courts website by clicking here.

Chapter 11: Chapter 11 is generally used by businesses to reorganize their debts and pay a portion of them over a plan period. It is similar (though much more complicated) to a Chapter 13. For more information regarding Chapter 11, visit the U.S. Courts website by clicking here.

Chapter 12: Chapter 12 is designed specifically for family farmers. It provides for the restructuring and payment of farm debts over the course of a plan period. For more information regarding Chapter 12, visit the U.S. Courts website by clicking here.

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