Vol 9 (2012) - Issue 5

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An Overview of Bankruptcy Law in the United States

I. Introduction
This overview of bankruptcy law in the United States is designed for lawyers trained outside of the U.S. As words may be used differently around the world, I begin with the terms creditor and debtor. While we ordinarily think of creditors and debtors in the context of a loan of money from the lender (creditor) to the borrower (debtor), the legal categories of creditor and debtor are much broader. In U.S. law, we can usefully define a debt as a duty that, through litigation, can be reduced to a court’s money judgment. For example, if David punches Peter in the nose, Peter may sue David in tort and win a money judgment against David. David’s duty to pay Peter is as much a 'debt' as a borrower’s duty to pay his lender.
Debtors and creditors include both humans and legal persons, such as corporations. The number of debtorcreditor relationships is enormous. For example, a seller of goods or services who has not yet been paid by its buyer is a creditor and its buyer is the debtor. An employee who is owed wages or salary is a creditor and her employer is the debtor. A plaintiff in a lawsuit arising out of an automobile accident is a creditor and the defendant – and probably also its insurance company – are debtors. As these examples suggest, most debtor-creditor relationships involve debtors who are not in bankruptcy. The law governing these debtors (and their creditors) is the foundation on which U.S. bankruptcy law is built, so I begin with an overview of non-bankruptcy debtor-creditor law.

II. Non-bankruptcy debtor-creditor law
A. General creditors
How do creditors collect what they are owed from debtors who are not in bankruptcy? Answers to this question vary among the fifty United States because most of the relevant law is enacted by state legislatures, rather than the U.S. Congress, and enforced by state courts, rather than federal courts.
Generally, a creditor who cannot persuade its debtor to pay must sue the debtor and win a judgment ordering the debtor/defendant to pay the creditor/plaintiff. As this point, we call the creditor a judgment creditor and the judgment creditor is entitled to compel payment of the judgment through several methods. While these methods (and the words used to describe them) vary among the fifty states, most states allow the judgment creditor to question the judgment debtor under oath. This often enables the judgment creditor to learn about the judgment debtor’s property and sources of income. Sometimes the judgment creditor will persuade the court to order the judgment debtor to turnover particular pieces of property to the judgment creditor. A judgment debtor who disobeys such an order (or a court’s order to submit to questioning) may be held in contempt of court. Among the sanctions for contempt of court is time in jail.
In most states, creditors can collect money judgments through judicial liens. For example, if the judgment debtor is employed, the creditor can get the clerk of the court to issue a writ of garnishment to the debtor’s employer. This writ basically instructs the employer to pay a portion of the judgment debtor’s future wages to the judgment creditor. Both federal and state law protect some amount of wages from garnishment, with some states going so far as to prohibit wage garnishment entirely. Even in these states, though, garnishing others who owe the judgment debtor is generally permitted. For example, bank accounts are often garnished.
If the judgment debtor owns land or goods, the judgment creditor can generally get the clerk of the court to issue a writ instructing the sheriff to take the debtor’s property and sell it. The proceeds of the sheriff ’s sale are generally paid first to reimburse the sheriff ’s expenses and then to the judgment creditor. This process (like garnishment) can continue until the judgment debt is paid in full. But, like the limits on wage garnishment, limits on this process are found throughout the fifty United States. All states define some property as exempt from creditor’s collection efforts. In other words, the sheriff is only authorised to take from the debtor (and sell) non-exempt property.