What is Bankruptcy?
Bankruptcy is a legal term for when a person or business cannot repay their outstanding debts. 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 outstanding debt.
The Uses of Bankruptcy
Bankruptcy offers an individual or business a chance to start fresh by forgiving debts that simply cannot be paid while offering creditors a chance to obtain some measure of repayment based on the individual's or business's assets available for liquidation. In theory, the ability to file for bankruptcy can benefit an overall economy by giving persons and businesses a second chance to gain access to consumer credit and by providing creditors with a measure of debt repayment. Upon the successful completion of bankruptcy proceedings, the debtor is relieved of the debt obligations incurred prior to filing for bankruptcy.
The Basics of Bankruptcy
All bankruptcy cases in the United States are handled through federal courts. Any decisions over federal bankruptcy cases are made by a bankruptcy judge, including whether a debtor is eligible to file or whether he should be discharged of his debts. But sometimes, administration over bankruptcy cases is handled by a trustee, someone appointed by the United States Trustee, an officer of the Department of Justice, to represent the debtor's estate in the proceeding. There is usually very little contact between the debtor and the judge unless there is some objection made in the case by a creditor.
Types of Bankruptcy Filings
Bankruptcy filings in the United States fall under one of several chapters of the Bankruptcy Code: Chapter 7, which involves liquidation of assets; Chapter 11, which deals with company or individual reorganizations and Chapter 13, which is debt repayment with lowered debt covenants or payment plans. Bankruptcy filing specifications vary among states, leading to higher and lower filing fees depending on how easily a person or company can complete the process.
Chapter 7 Bankruptcy
Individuals or businesses with few or no assets file Chapter 7 bankruptcy. The chapter allows individuals to dispose of their unsecured debts, such as credit cards and medical bills. Individuals with nonexempt assets, such as family heirlooms (collections with high valuations, such as coin or stamp collections), second homes and vehicles and cash, stocks or bonds, must liquidate the property to repay some or all of their unsecured debts. So, you're basically selling off your assets in order to clear away your debt. Consumers who have no valuable assets and only exempt property, such as household goods, clothing, tools for their trades and a personal vehicle up to a certain value, repay no part of their unsecured debt.
Chapter 11 Bankruptcy
Businesses often file Chapter 11 bankruptcy, the goal of which is to reorganize and once again become profitable. Filing Chapter 11 bankruptcy allows a company to create plans for profitability, cut costs and find new ways to increase revenue. 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 a business to continue conducting its daily operations without interruption while working on a debt repayment plan under the court's supervision. In rare cases, individuals file Chapter 11 bankruptcy.
Chapter 13 Bankruptcy
Individuals who make too much money to qualify for Chapter 7 bankruptcy may file under Chapter 13. The chapter allows individuals and businesses to create workable debt repayment plans. In exchange for repaying their creditors, the courts allow these debtors to keep all of their property including nonexempt property.
Other Bankruptcy Filings
The discharge of Chapter 7 is usually granted about four months after the debtor files to petition for bankruptcy. For any other type of bankruptcy, the discharge can occur when it becomes practical. Chapter 15 was added to deal with cross-border cases which involve debtors, assets, creditors and other parties who 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, he is no longer legally required to pay any of the debts on that order. So, any creditor listed on that discharge cannot legally undertake any type of collection activity (making phone calls, sending letters) against the debtor once the discharge order is enforced. Therefore, the discharge absolves the debtor of any personal liability for the debts specified in the order.
But 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, debts to the government, etc. In addition, any secured creditor can still enforce a lien against property owned by the debtor, provided that 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 the court before the deadline. This leads to the filing of an adversary proceeding in order to recover monies owe or enforce a lien.
The discharge from Chapter 7 is usually granted about four months after the debtor files to petition for bankruptcy. For any other type of bankruptcy, the discharge can occur when it becomes practical.
Pros and Cons
Declaring bankruptcy can help relieve you of your legal obligation to pay your debts and save your home, business or ability to function financially, depending on what kind of bankruptcy petition you file. But it also can lower your credit rating, making it more difficult to get a loan, mortgage, or low-rate credit card, or buy a home, apartment or business.
If you're trying to figure out if you should file, your credit is probably already damaged. A Chapter 7 filing will stay on your credit report for ten years, while a Chapter 13 will remain there for seven. Any creditors you hit up for debt (a loan, credit card, line of credit or mortgage) will see the discharge on your report, which will prevent you from getting any credit.