What Is Technical Bankruptcy?

Technical bankruptcy occurs when 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 and describes a firm with obsolete legacy software.

Key Takeaways

  • Technical bankruptcy is when a debtor cannot pay their debts but has yet to declare bankruptcy before a court.
  • Both individuals and companies can face technical bankruptcy.
  • Technical bankruptcy also refers to a company that neglects its software infrastructure to the point that its systems become obsolete.

Understanding Technical Bankruptcy

Technical bankruptcy often refers to a state in which a debtor—an individual or a company—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 filing for bankruptcy would make possible.

Generally, individuals in this position will seek such protection but may not be eligible if they have previously filed for bankruptcy. Others who qualify for protection may decide not to in order to avoid negative consequences, such as the severe impact filing has on their credit score. People with few to no assets to protect may come to the conclusion that filing for bankruptcy does not make sense.

Individuals who do choose to seek protection via a bankruptcy court will most commonly seek either Chapter 7 or Chapter 13 . Chapter 11 protection is available only to business entities.

If your debt is mostly in credit card balances you may be able to restructure your obligations to avoid formally filing for bankruptcy protection.

Technical Bankruptcy in Information Technology

Technical bankruptcy can also describe a situation in which a company neglects its technology 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 legacy systems. As a result, the company enters a stage known as technical debt. In this scenario, the term refers not to a financial debt but to the firm’s failure to stay current with external demands on its software systems.

Technical debt grows for a variety of reasons. Software architecture, for example, which is a comprehensive overview of the setup and functioning of a system, may be faulty, leading to bugs that accumulate over a period. The growth of technical debt tends to accelerate over time, deepening the hole into which a company finds itself. When the situation becomes unworkable, the firm is known to be in a state of technical bankruptcy.

Example of Technical Bankruptcy

Hugo is employed in a job where his salary is barely above minimum wage. He survives mainly on credit card debt. He does not own a house or other assets that can make him a good candidate for a loan, and his credit score is already considered poor.

His credit card debt soon reaches a point where he is unable to service it further. When collection agencies come calling, they discover that he is in technical bankruptcy, meaning he does not own assets or funds that could help him make payments and he has not filed for a bankruptcy before the courts.