Why Do People File Bankruptcy?
What Is Bankruptcy?
A business or person will file for bankruptcy if they do not have enough money to repay their debts, even if they sell all their assets. Bankruptcy is a legal proceeding. Usually, the debtor will file a petition for bankruptcy, though sometimes the creditors will file the petition. Once the debtor’s is in bankruptcy, the bankruptcy trustee is appointed by the United States to represent a debtor’s estate in a bankruptcy proceeding. The debtor’s assets will then be valued and sold to repay a portion of the debts.
Bankruptcy Basics:
- Federal bankruptcy courts handle the bankruptcy process
- The US Bankruptcy Code outlines the process
- Bankruptcy is a legal process that allows creditors to regain money and allows the bankrupt individual to seek freedom from debt.
Bankruptcy will clear debts but will make it difficult to borrow in the future because it stays on your credit reports.
How Does Bankruptcy Work?
Bankruptcy forgives debts that cannot be repaid. The bankrupt business or individual will liquidate any assets and repay the debts according to the bankruptcy proceedings. Once the bankruptcy proceedings are complete, the debt is wiped clean.
The federal court handles all bankruptcy proceedings and a bankruptcy judge will preside. A trustee will be appointed to represent the estate of the debtor during the proceeding. The debtor will not have much direct contact with the judge, the judge will mainly interact with the creditors and trustee.
What Are The Different Types of Bankruptcy?
There are a number of different types of bankruptcy depending on the circumstances of the debtor and their debts. Each type of bankruptcy will require different debt repayment schedules, bankruptcy filing costs, and other things.
Chapter 7 Bankruptcy
Chapter 7 Bankruptcy is for individuals and businesses that have no or few assets who need to dispose of unsecured debts. If the individual or business has the following assets, they must be liquidated to repay their unsecured debts:
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- Cash
- Family heirlooms with high valuations
- Second homes
- Bonds
- Stocks
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Personal vehicles under a certain value, clothes, trade tools, or certain household goods are not to be liquidated to pay down unsecured debt. This is the case if the debtor does not have any assets to liquidate, the creditor will just not receive payments in the bankruptcy proceedings.
Chapter 11 Bankruptcy
Chapter 11 Bankruptcy is often used by businesses to ensure they can reorganize and come back from bankruptcy. This allows a company to cut costs, create profitability plans, and look at new tactics to increase revenue. Preferred stockholders might receive payments in a Chapter 11 Bankruptcy, but common stock holders won’t. The business can continue operating during the bankruptcy proceedings and the court will create a debt repayment plan for them. Individuals can file for Chapter 11 Bankruptcy, but it is rare.
Chapter 13 Bankruptcy
If an individual or a business makes consistent income, then they may be eligible for Chapter 13 Bankruptcy. The court will create a debt repayment plan over 3-5 years that works with the debtor’s income. The bankruptcy court will allow the debtor to keep their assets on the condition that they make payments as per the repayment plan.
Other Types of Bankruptcy Filings
The above bankruptcy proceedings are the most common, but these types exist:
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- Chapter 9 Bankruptcy – For cities, towns, school districts, counties, or villages. This allows them to retain their assets and create a repayment plan.
- Chapter 10 Bankruptcy – A corporate bankruptcy type that no longer exists. In 1978 it was replaced by Chapter 11 Bankruptcy.
- Chapter 12 Bankruptcy – For family farms or fisheries to continue business operations while repaying debt on a modified repayment plan.
- Chapter 15 Bankruptcy – For cases where a creditor, debtor, asset, or any other party is in another country. This type of bankruptcy is filed in the home country of the debtor.
- Chapter 9 Bankruptcy – For cities, towns, school districts, counties, or villages. This allows them to retain their assets and create a repayment plan.
Bankruptcy Discharge Order
At the end of bankruptcy proceedings, the debtor will receive a discharge order that states they are no longer required to pay the debts named. Once the discharge order is executed, the creditor cannot make any collections attempts.
Not all debts will be discharged depending on the circumstances. The following debts may not be discharged:
- Alimony payments
- Child support
- Tax claims
- Government debts
- Personal injury debts
- Anything that was not listed by the debtor in the bankruptcy petition.
A secured creditor may enforce a lien against the debtor’s property.
When a debtor files a petition for bankruptcy, the creditors can object if they wish and file a proceeding to enforce a lien or recover money. The debtor will not automatically receive a discharge from their debts.
What Are the Advantages and Disadvantages of Bankruptcy?
The main advantage of bankruptcy for a debtor is that it frees you from your debts and allows you to rebuilt. Depending on the type of bankruptcy, it may also save your home or business.
The disadvantages of bankruptcy for the debtor is that it will affect your credit score for a few years. Chapter 7 bankruptcy will be on your credit score for ten years. Chapter 13 bankruptcy will remain on your credit score for 7 years.
This may make it more difficult to:
- Buy a house
- Rent an apartment
- Buy a business
- Get a credit card
- Get a loan
- Get a mortgage
You should weight up both options and consult a bankruptcy attorney if you are unsure. In many cases if you are considering bankruptcy, there is already damage to your credit score