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Why Does Bankruptcy Exist At All?

Why does bankruptcy exist at all?  I can tell you from past experience filing bankruptcies in Topeka that this question tends to be asked more often by creditors who are owed money than the debtors trying to discharge debt.  To the creditor owed money, the fact a person can go file bankruptcy can be a very frustrating reality indeed.  But for the person needing bankruptcy relief, the reason for bankruptcy is all too obvious.  At times, a person’s financial obligations can become so overwhelming that they become crippling.  Debts can become so overwhelming that they become a sort of financial bondage that takes away a person’s hope for future prosperity and ability to take care of his or her children.  From my experience as a bankruptcy lawyer, I have found that none of my clients want to file bankruptcy, and all of them wish they had the financial capacity to repay their debts; they have simply reached a point in their lives where that is impossible. This is where bankruptcy comes in.  The reason for bankruptcy is multifaceted.  First, bankruptcy serves to provide a debtor with new hope and a fresh start.  The United States Supreme Court has stated that this fresh start is the “essence of modern bankruptcy law” and that debtor is provided with special protections in bankruptcy called exemptions “to ensure that bankruptcy will provide a fresh start.” Local Loan Co. v. Hunt, 292 U.S. 244 (1934). From more of a macro-economic perspective, bankruptcy is an essential part of any capitalistic economy.  Without bankruptcy, without the knowledge that if a business endeavor went south bankruptcy can serve as a safety hatch, what business man would ever take a risk?  While it is clear no one wants to file bankruptcy, bankruptcy itself provides for an invaluable safety net that will allow a person to take the debts from the past and move forward into a brighter future. What about the creditors?  I am glad you asked.  While it is not immediately obvious why bankruptcy would benefit creditors, there is something in it for them too.  First of all, for the sake of this blog article, we have to start at the assumption that a person who is looking at filing bankruptcy is out of financial options.  That means that he or she has already sold the yacht and the private island and has already emptied out the Swiss bank account (tongue in cheek).  In my experience, most bankruptcy debtors generally have little more than their household furnishings, their car, and their home, if they are lucky.  By the very reality of their situation, no one is getting paid in full, bankruptcy or not.  So, before we assume bankruptcy is unfair for creditors, we have to acknowledge that the alternative is not likely much better, if any better at all. With that understanding, what bankruptcy does is it equalizes treatment of creditors, at least with in particular classifications.  For example, creditors are broken up into at least three different classes: Secured, Priority, and General Unsecured, Non-priority.  Suppose that Ace Debt Collection Law Firm is collecting on a credit card owed to Goliath National Bank (yes, that is a How I Met Your Mother reference), and Ace Debt Collection Law Firm was more aggressive in its debt collection, pursued a collection lawsuit against the debtor, got a judgment, and began to garnish the debtor’s paycheck to the fullest extent allowed by law.  And by doing so, Ace Debt Collection Law Firm collected for Goliath National Bank $2,000.00 in three months.  Well, there is a bankruptcy law that creates a legal presumption that if an unsecured creditor is paid more than $600 within 90 days of the debtor filing bankruptcy (even by garnishment), that creditor was treated with a preference.  This means that the bankruptcy trustee can force Goliath National Bank to turn over the $2,000 so the trustee can distribute that money equally among all of the General Unsecured, Non-Priority Creditors.  So, from that perspective, even creditors may benefit by some equalization under the bankruptcy code. So bankruptcy actually exists for both the creditor and the debtor: to ensure fair treatment of the creditors (as much as possible given the circumstances), and to help the debtor get a fresh start. by Adam Mack, J.D.