What is 'Technical Bankruptcy'

Technical bankruptcy can refer to a state in which a borrower is unable to make payment on a debt obligation but has yet to officially declare bankruptcy before a legal authority. In technical bankruptcy, the debtor would likely qualify for protections but neither the debtor nor their creditors have taken up formal legal action in a bankruptcy court.

A second meaning for technical bankruptcy comes from the field of information technology. This describes a firm with obsolete legacy software.

BREAKING DOWN 'Technical Bankruptcy'

Technical bankruptcy often refers to a state in which a debtor has defaulted on a debt and would likely qualify for bankruptcy protection but has yet to formally file for protection in a bankruptcy court. Without filing for bankruptcy, a debtor foregoes the short-term benefits of a court-ordered automatic stay. The stay prevents creditors from pursuing repayment via collection calls, lawsuits or wage garnishments. A debtor with real estate assets does not receive foreclosure or eviction protection that would be possible via bankruptcy filing.

Generally, individuals in this position will seek such protection but may be prevented from doing so if they have previously filed for bankruptcy. Others who qualify for protection may decline to do so in order to avoid negative consequences such as the severe impact filing has on their credit rating. Individuals with little to no assets to protect may determine that filing bankruptcy does not make sense. Others whose debt is mostly in credit card balances may be able to restructure their obligations to avoid formally filing for bankruptcy protection.

Those individuals who do choose to seek protection via a bankruptcy court will most commonly seek either Chapter 7 or Chapter 12 coverage. Chapter 11 protection is available only to commercial entities.

Technical Bankruptcy in Information Technology

Technical bankruptcy can also describe a situation in which a company neglects its software infrastructure to the point that its systems become obsolete. Such a firm fails to maintain its systems as bugs appear and regulatory changes require updating of legacy systems. As it does so, the company enters a stage known as technical debt. This term refers not to a financial debt but to the firm’s failure to stay current with external demands on its software systems.The growth of this debt tends to accelerate over time, deepening the hole into which such a company finds itself. When the situation becomes unworkable, the firm is known to be in a state of technical bankruptcy.

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