What Is Bankruptcy? Forbes Advisor

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Bankruptcy is a legal process that lets individuals or businesses overburdened with debt eliminate debts and start fresh or, in some cases, work out deals with creditors to pay debts off manageably. It also gives creditors a way to recoup debts they may otherwise have to write off.

The U.S. Bankruptcy Code governs all bankruptcy filings. All cases are filed and heard in special federal courts. Ninety of these bankruptcy courts operate across the United States. While local procedural differences may exist, federal and not state or local law directs what happens in bankruptcy.

A federal bankruptcy judge oversees the court and makes important decisions, like which debts can be eliminated. However, a court-appointed trustee does the heavy lifting, which mostly occurs away from the courthouse. A debtor may never meet the judge or even appear in court.

Details depend on the type of bankruptcy, but in broad outline, the process involves:

An important point is that as soon as a debt is approved to be discharged, creditors must stop trying to collect it. This means no more phone calls, letters or lawsuits. Still, its often a difficult event for most filers, as a bankruptcy filing impacts credit scores and can be a lot of work.

The history of bankruptcy law in the United States is long and has gone through several iterations and repeals since its introduction in the early 1800s. It wasnt until 1898 that Congress passed the first enduring federal bankruptcy law, the Bankruptcy Act of 1898. The law has been amended and replaced, but at no time since has the federal government lacked a bankruptcy law, as it did at times before its passage. The Bankruptcy Reform Act of 1978, known as the Bankruptcy Code, replaced the amended Bankruptcy Act of 1898 and is the current law that governs bankruptcy cases.

Today, after many refinements of that original law, bankruptcy has become a standard feature of personal and business finance. Notably, bankruptcy filings have been declining in recent years.

Overall, bankruptcy filings have fallen sharply since the start of the Covid-19 pandemic. According to statistics released by the Administrative Office of the U.S. Courts, personal and business bankruptcy filings fell 29.1% for the 12-month period ending Sept. 30, 2021. Filings decreased by 29.7% from 2019 to the end of 2020.

Six types of bankruptcy exist, though some are used more often than others. Each is named after the bankruptcy code chapter that describes how they work. A person or organization seeking bankruptcy can, within limits, choose the type of bankruptcy they want to file.

Here are the three most common types of bankruptcy.

Chapter 7 is one of the most common ways individuals get relief from debts through bankruptcy. In some cases, businesses may choose to file Chapter 7. As part of a Chapter 7 filing, the debtor turns over his or her assets to a bankruptcy trustee. The trustee sells the assets and makes distributions to creditors from the proceeds. Whether creditors get all, part or none of the money owed them, a Chapter 7 filing ends their claims against the debtor, except for some debts that cant be erased this way. Only people who lack the means to repay their debts can use Chapter 7.

An individual debtor filing under Chapter 13 doesnt have to liquidate assets. Instead, creditors and debtors work out a plan to repay the debts. The plan doesnt erase debts, but it allows debtors to pay the debt back over time, typically three to five years. Debtors who have enough income to pay all or part of their debts must use Chapter 13 instead of Chapter 7.

Chapter 11 is mainly for businesses that need to work out new repayment plans with their creditors. Its for companies that expect to continue operating after bankruptcy reorganization. The court approves or disapproves of the plan of reorganization, although creditors get to evaluate the plan. Companies that dont plan to continue operating may go through liquidation bankruptcy.

Bankruptcy cant eliminate every type of debt. The specifics vary by chapter, but here are some common types of debt that may not be wiped out through bankruptcy:

Any debt arising from personal injury or death as a result of driving while intoxicated also will survive bankruptcy. So will fines and financial restitution imposed after a criminal conviction.

These arent hard and fast categories. For instance, student loans may be discharged in bankruptcy if the debtor can show repayment would cause an undue hardship.

Shepherding a case through the bankruptcy courts is a complicated process and calls for great attention to detail. While its possible to file for bankruptcy without legal assistance, especially in uncomplicated Chapter 7 liquidation proceedings, it could be wise to hire an attorney.

Bear in mind that creditors will certainly be lawyered up. And, while the judge and trustee can generally be relied upon to act impartially, neither will give legal advice.

The fresh start bankruptcy offers is not a perfectly clean slate. Bankruptcy can have serious and long-lasting financial consequences.

Bankruptcy shows on your credit report for a long time. Chapter 13 filings stick around for seven years; a Chapter 7 ding persists for 10 years.

The presence of a bankruptcy on your report can drastically lower your credit score. In general, you may find it more difficult to get a mortgage, car loan, credit card or personal loan for as much as a decade after declaring bankruptcy.

Bankruptcys negative consequences dont last forever. After bankruptcy, its possible to rebuild your credit and regain your former standing as a reliable borrower. Heres how:

Bankruptcy isnt necessarily right for every situation. You may be better off using one of several alternatives. They include:

Carefully evaluate the pros and cons of these alternatives to see whether bankruptcy is a better option. For instance, using home equity to pay off creditors preserves your credit rating but places your home at risk.

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The world of bankruptcy has its own jargon. Here are some technical terms likely to show up:

Bankruptcy can be a boon to debtors and creditors alike, helping settle accounts in an organized manner that is as fair as possible to all parties. Its not necessarily easy or quick, but, in some cases, bankruptcy is a workable solution to what could otherwise be an untenable debt problem.

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What Is Bankruptcy? Forbes Advisor