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Why Filing for Bankruptcy is Done in Federal (Not State) Courts

November 13th, 2017 Bankruptcy

Last year, nearly 10,000 Arkansans filed for bankruptcy. Filing for bankruptcy in Arkansas requires going to one of a handful of locations throughout the state—all of which are courthouses or offices of the U.S. Bankruptcy Court for the Eastern and Western Districts of Arkansas, a federal court.

Isn’t that odd? When you’re injured, you can often file a lawsuit either in state court or federal court. Likewise, when you sue someone for breaching a contract, you may be able to do so in a state or federal court. Yet, as any bankruptcy lawyer will tell you, you can only file for bankruptcy in federal court—Arkansas state courts (or any other state’s courts) cannot help you.

This post considers why that is, and the major role that states play in our bankruptcy system even though their courts are kept out of it. The answer starts at the very beginning—the U.S. Constitution.

U.S. Constitution: The Bankruptcy Clause

Most of the time when people talk about the Constitution, they are referring to the Bill of Rights, the set of 10 amendments that were ratified shortly after the Constitution itself. This is the part of the Constitution that protects Americans’ rights to freedom of speech, free exercise of religion, and against unreasonable searches and seizures, among others.

But the Constitution is not just the Bill of Rights. As originally enacted, the Constitution was primarily structural, defining how the newly formed federal government would be organized and what powers it would have.

Article I, section 8 of the Constitution is one of those important structural provisions. It defines the scope of the U.S. Congress’ authority. The fourth clause of that section includes the Bankruptcy Clause, which gives Congress the power to create a uniform law of bankruptcy for the nation.

Why was this done? To answer that question, James Madison—often referred to as the Father of the Constitution—pointed to the closely related Commerce Clause, which immediately precedes the Bankruptcy Clause. The Commerce Clause empowers Congress to regulate commerce among the states.

Madison argued that having a uniform, nationwide bankruptcy law was an important element of Congress’ power to regulate interstate commerce. If each state could independently protect debtors from their out-of-state debts, this would stymie Congress’ efforts to regulate commerce at a national level.

The Bankruptcy Code

Congress has exercised its power over bankruptcies in different ways throughout American history. Today, bankruptcies in the United States are governed by the U.S. Bankruptcy Code, which is codified as Title 11 of the U.S. Code.

The Bankruptcy Code defines several different types of bankruptcy, organizing them in different “Chapters.” For individuals, the two most important types of bankruptcy are Chapter 7 bankruptcies and Chapter 13 bankruptcies. You can read our comparison of Chapters 7 and 13 here.

To hear cases brought under the Bankruptcy Code, Congress has created a series of specialized federal bankruptcy courts. Normally, each federal court district features one bankruptcy court. For example, Oklahoma is divided into three federal districts, the Northern District, the Eastern District, and the Western District. Each of these districts has a U.S. Bankruptcy Court.

(The U.S. Bankruptcy Court for the Eastern and Western Districts of Arkansas is unique in this regard, since it is the only bankruptcy court in the nation to span two districts.)

How States Are Involved in Bankruptcy

Although the Bankruptcy Code is federal law, and all bankruptcy cases are filed in federal court, the states do play an important role in how bankruptcy works. Specifically, the Bankruptcy Code authorizes each state to define what bankruptcy exemptions its residents may use when they file for bankruptcy.

Bankruptcy exemptions protect certain types of property in a Chapter 7 proceeding from being sold by the bankruptcy trustee. They also affect what property is considered in a Chapter 13 bankruptcy when developing a repayment plan.

Of course, these state-based differences in exemptions could present the opportunity for debtors to game the system by moving to a state with more favorable exemptions and immediately filing for bankruptcy. The Bankruptcy Code and related federal law include several features that help reduce this risk:

  • Venue Requirements: “Venue” determines the court or courts where a case may or must be filed. 28 U.S.C. § 1408 generally requires bankruptcy petitions to be filed in the federal court district where the debtor has lived for the longest time during the 180 days before filing. For instance, if you just moved to Arkansas from Oklahoma, don’t expect to be filing for bankruptcy in Arkansas for at least a few months.
  • Choice of Exemptions Law: A debtor doesn’t qualify to use a state’s exemptions simply by filing for bankruptcy in that state. Instead, courts generally use the exemptions of the state where the debtor lived for the past two years. If the debtor lived in multiple states during that period, the court uses the exemptions of the state where the debtor lived for the longest time during the 180 days before those two years.
  • Restrictions on Unlimited Homesteads: Some states’ exemptions protect a debtor’s home regardless of its value. For instance, Arkansas limits its homestead exemption primarily by acreage, not value. However, the Bankruptcy Code limits a homestead exemption to $160,375 in value if the home was acquired within the last 1,215 days.

In short, although state courts do not play a role in deciding bankruptcy cases, the states themselves nevertheless contribute to the process in important ways.

Are You Considering Filing for Bankruptcy in Arkansas or Oklahoma?

Filing for bankruptcy is always a difficult decision, because it comes with significant tax, legal, and social consequences. If you are considering filing for bankruptcy in Arkansas or Oklahoma, contact a bankruptcy lawyer from Nolan Caddell Reynolds, who can help you explore your options in greater detail and develop the optimal plan for your circumstances.

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