Bankruptcy can provide financial relief in the form of a restructured debt repayment plan or a liquidation of certain assets to pay off a portion of your debt. Although bankruptcy may be unavoidable for some, it can severely damage your credit score, so it’s crucial to pursue all alternatives before considering it.
Bankruptcy is a legal process that eliminates all or part of your debt, though not without serious consequences. Understanding the bankruptcy process, including the different options and their ramifications, can help you determine whether the benefits are worth the drawbacks.
What Is Bankruptcy?
Bankruptcy is a legal proceeding initiated when a person or business is unable to repay outstanding debts or obligations. It offers a fresh start for people who can no longer afford to pay their bills.
The bankruptcy process begins with a petition filed by the debtor, which is most common, or on behalf of creditors, which is less common. All of the debtor’s assets are measured and evaluated, and the assets may be used to repay a portion of the outstanding debt.
How Bankruptcy Works
Bankruptcy offers an individual or business a chance to start fresh by forgiving debts that they can’t pay. Meanwhile, creditors have a chance to get some repayment based on the individual’s or business’s assets available for liquidation.
In theory, the ability to file for bankruptcy benefits the overall economy by allowing people and companies a second chance to gain access to credit. It can also help creditors regain a portion of debt repayment. A bankruptcy judge makes decisions, including whether a debtor is eligible to file and whether they should be discharged of their debts.Administration over bankruptcy cases is often handled by a trustee, an officer appointed by the United States Trustee Program of the Department of Justice, to represent the debtor’s estate in the proceeding. The debtor and the judge usually have no contact unless there is some objection made in the case by a creditor. When bankruptcy proceedings are complete, the debtor is relieved of their debt obligations.
What Are the Types of Bankruptcy Filings?
Bankruptcy filings in the United States are categorized by which chapter of the Bankruptcy Code applies. For example, Chapter 7 involves the liquidation of assets, Chapter 11 deals with company or individual reorganizations, and Chapter 13 arranges for debt repayment with lowered debt covenants or specific payment plans.
Chapter 7 Bankruptcy
Most people file for Chapter 7 bankruptcy, which allows you to dispose of unsecured debts, such as credit card balances and medical bills.
You must liquidate property to repay some or all of your unsecured debts if you have nonexempt assets, such as family heirlooms (collections with high valuations, like coin or stamp collections), second homes, or investments like stocks or bonds.
When you file Chapter 7 bankruptcy, you essentially sell off your assets to clear debt. People who have no valuable assets and only exempt property—such as household goods, clothing, tools for their trades, and a personal vehicle worth up to a certain value—may end up repaying no part of their unsecured debt.
Chapter 11 Bankruptcy
Businesses often file for Chapter 11 bankruptcy, with the goal of reorganizing and remaining in business. Filing Chapter 11 bankruptcy gives a company the opportunity to create plans for profitability, cut costs, and find new ways to increase revenue. Its preferred stockholders, if any, may still receive payments, though common stockholders will be last in line.4
For example, a housekeeping business filing Chapter 11 bankruptcy might increase its rates slightly and offer more services to become profitable. Chapter 11 bankruptcy allows the business to continue conducting its business activities without interruption while working on a debt repayment plan under the court’s supervision. In rare cases, individuals can also file for Chapter 11 bankruptcy.
Chapter 13 Bankruptcy
Individuals who make too much money to qualify for Chapter 7 bankruptcy may file under Chapter 13, also known as a wage earner’s plan. It allows individuals—as well as businesses, with consistent income—to create workable debt repayment plans.
The repayment plans are commonly in installments over the course of a three- to five-year period. In exchange for repaying their creditors, these debtors are allowed, per the courts, to keep all of their property, including otherwise nonexempt property.6
Other Bankruptcy Filings
While Chapter 7, Chapter 11, and Chapter 13 are the most common bankruptcy proceedings, there are several other types:
- Chapter 9 bankruptcy is available to financially distressed municipalities, including cities, towns, villages, counties, and school districts. Under Chapter 9, municipalities do not have to liquidate assets to repay their debts but are instead allowed to develop a plan for repaying them over time.7
- Chapter 10 bankruptcy, which effectively ended in 1978, was a form of corporate bankruptcy that has been supplanted by Chapter 11.
- Chapter 12 bankruptcy provides relief to family farms and fisheries. They are allowed to maintain their businesses while working out a plan to repay their debts.8
- Chapter 15 bankruptcy was added to the law in 2005 to deal with cross-border cases, which involve debtors, assets, creditors, and other parties that may be in more than one country. This type of petition is usually filed in the debtor’s home country.
Being Discharged From Bankruptcy
When a debtor receives a discharge order, they are no longer legally required to pay the debts specified in the order. What’s more, any creditor listed on the discharge order cannot legally undertake any type of collection activity (such as making phone calls or sending letters) against the debtor once the discharge order is in force.However, not all debts qualify to be discharged. Some of these include tax claims, anything that was not listed by the debtor, child support or alimony payments, personal injury debts, and debts to the government. In addition, any secured creditor can still enforce a lien against property owned by the debtor, provided that the lien is still valid.Debtors do not necessarily have the right to a discharge. When a petition for bankruptcy has been filed in court, creditors receive a notice and can object if they choose to do so. If they do, they will need to file a complaint in court before the deadline. This leads to the filing of an adversary proceeding to recover money owed or enforce a lien.
FAQs
What is bankruptcy?
Bankruptcy is a legal status that declares an individual or business unable to repay their outstanding debts. It provides a legal framework for the resolution of debts and the distribution of assets.
Who can file for bankruptcy?
Individuals, businesses, and even municipalities can file for bankruptcy. The eligibility criteria and the type of bankruptcy available may vary based on the debtor’s circumstances.
What is Chapter 7 bankruptcy?
Chapter 7 bankruptcy involves the liquidation of assets to pay off debts. Certain assets may be exempt from liquidation, and remaining eligible debts are discharged, providing a fresh start for the debtor.
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