Contrary to popular belief, filing for bankruptcy is not a "magic pill" that has the power to cure all of your financial problems. If you're struggling to make ends meet, it's up to you to do everything in your power to avoid insolvency. Bankruptcy leaves a lasting black mark on your credit profile and may have serious unintended consequences, including job loss and foreclosure. In situations where bankruptcy is unavoidable, the venue in which you file may play a crucial role in your case's eventual outcome. Learn more about some major differences between state and federal bankruptcy laws.
First, it's important to review the general parameters of U.S. bankruptcy filings. For individuals, there are two major types of bankruptcy: Chapter 13 and Chapter 7. Chapter 13 allows debtors to negotiate with their creditors to "restructure" their debts with the help of a judge. Chapter 7 lets debtors liquidate their assets in an orderly fashion and pay off certain creditors in the process. Both processes can take months and may affect borrowers' credit profiles for many more years.
There are also two major types of debt. Since "secured" debts are tied to specific pieces of collateral, their issuers take precedence over "unsecured" creditors who lend to customers in good faith. Secured debts like student loans, home loans and car notes can't be forgiven in bankruptcy. In Chapter 13 filings, they're often left untouched. In Chapter 7 filings, they're often settled with the proceeds from sales or seizures of the filer's assets. By contrast, unsecured debts like business loans and credit card balances are far more malleable. In Chapter 13 filings, they can be restructured to give borrowers more time to pay them off. In Chapter 7 filings, certain unsecured debts can be completely eliminated or "discharged."
1. The "Feds" and "Staties" Don't Rule on the Same Issues
Most bankruptcy cases are initially filed in federal court and are governed by the provisions of federal bankruptcy law. Indeed, the federal government enacted changes to its bankruptcy laws during the mid-2000s in an attempt to simplify and streamline this process. In all cases, a federal judge or federally appointed legal actor must rule on the merits of a specific bankruptcy case and determine whether it may proceed. However, state-specific legal frameworks have a powerful effect on the outcomes of many bankruptcy cases. For instance, wage garnishments and asset seizures are usually initiated at the state level. Each state also maintains its own set of property exemptions to protect filers from destitution.
2. State Exemptions Tend to Be More Generous
Although the federal government offers a specific property exemption for which all filers are eligible, most states maintain more generous exemptions. Specifically, the federal "homestead exemption" that ostensibly protects filers from foreclosure is capped at a low level that's often insufficient for more expensive homes. By contrast, some states have functionally unlimited homestead exemptions that shield Chapter 13 filers from foreclosure under most circumstances.
3. State Bankruptcy Cases May Not Be Eligible for Federal Appeal
Although state bankruptcy laws tend to be more lenient than their federal counterparts, they offer less room for error. This is because state and federal court systems remain separate under normal circumstances. In the event of an unfavorable state-level decision, borrowers may be unable to appeal to a higher federal court. As such, using the federal exemption schedule tends to remove some of the uncertainty from the proceedings.
Final Thoughts: State or Federal?
There's no simple answer to this question. While some states offer generous bankruptcy exceptions and may take a more hands-on approach to the discharge of certain debts, federal law generally provides more opportunities for favorable appeals. Ultimately, your choice of filing venue will depend on your specific circumstances and your degree of confidence with the general process. No matter where you decide to file, remember to remain positive and vigilant.
