What is BANKRUPTCY? Definition, How it Works, Types and Impact

What is Bankruptcy?

Bankruptcy is a court proceeding where a judge and court trustee examine the assets and liabilities of individuals and businesses who find it difficult to pay bills and decide whether those debts can be discharged so they are no longer legally required to repay them. These laws were written to enable individuals whose finances crumble due to bad decision making to have a fresh start. These individuals and businesses that file for bankruptcy usually have huge debts than their money can cover. There is no perfect time to file for bankruptcy. But, if you discover that paying off all debt could take more than half-a-decade, it could be the best time to file for one.

How Bankruptcy Works

Filing for bankruptcy gives an opportunity for a fresh start. An individual or business not being able to pay all debt over a particular period of time is the primary reason for filing for bankruptcy. A secondary reason for filing is to stop the constant phone calls, emails, letters and other means used by creditors to contact debtors in order to collect their credits.

Legally, bankruptcy gives automatic stand-down instruction. Creditors will be prohibited from filing a suit against the business or individual as well as contacting debtors to pay their credits. It also protects against eviction, utility disconnection, and wage garnishments.

The process of declaring bankruptcy is quite long and could take about 6 months to one year before completion.

Types of Bankruptcy

Depending on the kind of debt being incurred, there are several types of bankruptcy.

Chapter 7 Bankruptcy

Chapter 7 bankruptcy gives an individual the opportunity to get a court judgment that releases him from the responsibility of paying debts. Key assets (exempt properties) like a house, car, pension, Social Security checks, welfare and retirement packages will be kept, while non-exempt properties will be sold off to repay debt. Non-exempt properties such as cash, bank accounts, stock investment, stamp collections, a second car, and second home are often liquidated and the proceeds are used to repay creditors. These items are usually sold by a court-appointed bankruptcy trustee.

Chapter 13 Bankruptcy

This kind of bankruptcy involves repaying some part of the debt and being forgiven for the rest. It is used by individuals who do not want to want to give up their properties or do not qualify for Chapter 7 because they have a high income. People can only file for bankruptcy under Chapter 13 if their debts do not exceed a certain amount. Under Chapter 13, a three- to five-year repayment plan is designed for the creditors. When the plan is successfully completed, the remaining debts are erased.

Chapter 9 Bankruptcy

This kind of bankruptcy applies to cities or towns, where it protects the municipalities from creditors while the city develops a plan for handling its debts. This usually happens when industries close down and people leave to find jobs elsewhere.

Chapter 11 Bankruptcy

Chapter 11 bankruptcy is often referred to as reorganization bankruptcy. It is designed for businesses and gives businesses a chance to stay open, while the debts and assets of the business is being restructured so that creditors can be paid.

 Chapter 12 Bankruptcy

This applies to family farms and fisheries, and gives them the chance to propose a plan to repay all or part of their debts. The debt of individuals, partnerships or corporations filing for Chapter 12 must not exceed $4.03 million for farmers and $1.87million for fishermen. The repayment plan must be completed within five years, though allowances are made for the seasonal nature of both farming and fishing.

Chapter 15 Bankruptcy

This kind of bankruptcy applies to cross-border insolvency cases, where a debtor has assets and debts in both the U.S. and another country. This chapter was added to the bankruptcy code in 2005 as part of the Bankruptcy Abuse Prevention and Consumer Protection Act. Chapter 15 cases start as insolvency cases in a foreign country and make their way to the U.S. Courts to try and protect financially troubled businesses from going under. The U.S. courts limit their scope of power in the case to only the assets or persons that are in the United States.

Are you considering filing bankruptcy? Make sure you speak to your financial advisor and your lawyer before moving forward.  Examine all the types of bankruptcies discussed above to see which one fits your condition. 

Impact of Bankruptcy

•       It offers an opportunity for a fresh start, hence giving the individual and business a second chance.
•       When a bankruptcy is filed for, an individual could be denied new lines of credit or even jobs.
•       Bankruptcy could damage credit reports.
•      It can take over 7 years to be discharged from some types of bankruptcy.
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