Bankruptcy

Definition

The term bankruptcy is used to describe the legal status of an individual or company that cannot repay money owed to creditors.  Debtors file for bankruptcy status, which is then ordered by a court of law.

Explanation

Bankruptcy is a legal matter, and should be pursued only after exhausting alternatives such as budgeting, seeking the assistance of a credit counselor and debt consolidation.  There are a total of six bankruptcy chapters, four of which are commonplace; however only two forms apply to individuals:

Chapter 7

Also known as liquidation, Chapter 7 bankruptcy eliminates most of the debt the individual owes, and repayment is not necessary.  In bankruptcy court, the individual would provide a list of all property owned and property desired to be exempt from the bankruptcy proceeding.  Outstanding loans on property the court allows the individual to keep still needs to be repaid.  The trustee of the bankruptcy has the right to sell, or liquidate, all non exempt assets.

A Chapter 7 bankruptcy proceeding may not discharge all debt obligations. For example, student loans, alimony, child support, and property taxes may still be outstanding and in need of repayment.

Chapter 9

Municipalities such as school districts, townships, cities, and counties can seek protection from creditors by filing for municipal bankruptcy, also known as Chapter 9.  Unlike Chapter 7, whose purpose is to liquidate the assets of the filing entity, Chapter 9 allows the municipality to reorganize their debt by negotiating a repayment plan that is acceptable to creditors.  This reorganization can include the lowering of interest rates on loans, extending the payment terms, as well as debt elimination.

Chapter 11

Also known as corporate bankruptcy, Chapter 11 allows the company to reorganize its debt.  In doing so, the company is allowed to continue to operate as long as it meets its newly constructed repayment plans to creditors.

Under Chapter 11, an automatic stay requires creditors to stop all activities associated with the collection of outstanding debt.  The company's management team would then negotiate with creditors to restructure debt repayment plans.  A court-appointed trustee oversees the restructuring plan and can force liquidation under Chapter 7 if the company does not adhere to its repayment plan.

Chapter 12

Unique to the families of farmers and fishermen, Chapter 12 is similar to Chapter 13 since it allows these families to restructure payments and repay debt obligations over a three to five year timeframe.  Chapter 12 is less complicated, and less expensive, to file than both Chapter 11 and 13.  Congress specifically designed many of the features of Chapter 12 to help farmers and fishermen structure successful repayment plans.

Chapter 13

As is the case with Chapter 11, individuals can reorganize their debt under Chapter 13.  Generally, Chapter 13 bankruptcy applies to individuals with less than $250,000 in unsecured debt and $750,000 in secured debt.

  • Unsecured debt does not include collateral as a guarantee of payment.  For example, credit card debt is unsecured debt.
  • Secured debt is secured through collateral or tangible property. A mortgage is a loan that is secured with the home as property. In case of default on the loan, the lender can seize the property to help recover the remaining balance owed.

Chapter 13 allows the individual to restructure payments and repay debt obligations over a three to five year timeframe.

Chapter 15

In cases involving bankruptcies originating outside of the United States, Chapter 15 allows foreign courts access to the assets of the debtor as well as offering protections from the debt collection practices of creditors such as automatic stays.  U.S. courts can conduct hearings to determine the types of assistance offered to foreign creditors.

Related Terms

leverage, debt negotiation, debt consolidation, credit score