Bankruptcy: A Complete Guide
The word “bankruptcy” alone is enough to make most people shudder. Because of its reputation for significantly damaging credit scores for seven to 10 years, bankruptcy is usually considered to be a last-resort option.
But despite its bad rap, nearly 400,000 people still filed for non-business bankruptcies in 2021. So why might someone file for bankruptcy? Our helpful guide* sheds light on what bankruptcy is, how it works, and why someone might choose to pursue it.
Table of contents
- What is bankruptcy?
- What are the different types of bankruptcy?
- Bankruptcy discharges
- What assets are protected in bankruptcy?
- Why people declare bankruptcy
- What are some alternatives to bankruptcy?
What is bankruptcy?
Very simply put, bankruptcy is the legal process of allowing someone to clear some or all of their debt, and/or make a repayment plan. Bankruptcies are handled in federal courts and are therefore a matter of public record. Individuals, spouses, or corporations and similar entities can file.
Established by the Supreme Court in 1934, the rules of bankruptcy were put in place to give “the honest but unfortunate debtor…a new opportunity in life and a clear field for future effort, unhampered by the pressure and discouragement of preexisting debt.”
Declaring bankruptcy can offer filers a lot of relief—but it can also come with some serious setbacks.
How to declare bankruptcy
Bankruptcy cases normally begin when a debtor files a petition with their jurisdiction’s bankruptcy court.
Although it's possible to on your own—called filing “pro se”—experts strongly recommend seeking the help of a professional bankruptcy lawyer so that you fully understand all the long-term legal and financial consequences of filing.
The bankruptcy process
Most of the bankruptcy process is administrative and conducted outside of the courthouse, usually by a court-appointed trustee assigned to the case.
Typically, the only formal proceeding a debtor needs to attend is a meeting of the creditors, sometimes called a 341 Meeting, held at the trustee’s office. This meeting, required by Section 341 of the Bankruptcy Code, is an opportunity for the creditors to question their debtor about their debts and property.
However, each judicial district in the country has its own federally-appointed bankruptcy judge who has the ultimate decision-making power to decide someone’s eligibility for filing and whether a discharge should be made. In some cases, the debtor might be required to appear in front of their district’s judge for a hearing.
Overall, the full bankruptcy process itself differs depending on the type of bankruptcy you’re filing. All procedural aspects of bankruptcy are fully defined in the Federal Rules of Bankruptcy but may vary depending on your local bankruptcy court’s rules.
What are the different types of bankruptcy?
There are several types of bankruptcy outlined in the U.S. Bankruptcy Code, but the most common types of bankruptcy filed by individuals are Chapter 7 and Chapter 13.
Chapter 7 – Liquidation
- Trustee reduces a debtor’s estate to its cash value and distributes to creditors
- Cases can include nonexempt property (i.e., property that can be liquidated), but usually do not
- To qualify, debtors must pass a “means test” to gauge their ability to repay their creditors on their own and ensure they aren’t abusing the bankruptcy system
Chapter 9 – Adjustment of Debts of a Municipality
- Can only be filed by a municipality (e.g., cities, towns, school districts, counties, etc.)
- Similar to reorganization under Chapter 11
Chapter 11 – Reorganization
- Usually filed so that a commercial enterprise can continue to operate while repaying creditors
- Reorganization plan is court-approved, with the goal of the enterprise returning to profitability
- Some debts must be repaid, while others can be discharged
- Debtor can plan to terminate certain contracts/leases, recover assets, and rescale operations
Chapter 12 – Adjustment of Debts of a Family Farmer or Fisherman with Regular Annual Income
- Allows a family farmer or fisherman to continue operating their business while repaying creditors
- Similar to Chapter 13 process, with proposal to repay over a period of no more than three years
Chapter 13 – Adjustment of Debts of an Individual with Regular Income
- Often filed by people who do not pass the Chapter 7 means test
- Debtor can propose a plan to repay debts over time, usually three to five years, which must be approved by the court
- Debtor may have to make an appearance in front of a judge for their plan confirmation hearing
- Debtor is protected from lawsuits while their repayment plan is in effect
- After the repayment plan period, remaining debts are discharged
Chapter 15 – Ancillary and Other Cross-Border Cases
- Provides procedures for dealing with debt across borders
- Filed when the debtor or their property is subject to the laws of both the U.S. and one or more foreign countries
- Bankruptcy filings drop 24 percent. United States Courts. (2022, February 4). Retrieved from https://www.uscourts.gov/news/2022/02/04/bankruptcy-filings-drop-24-percent
- Bankruptcy. United States Courts. (n.d.). Retrieved from https://www.uscourts.gov/services-forms/bankruptcy
- Local Loan Co. v. Hunt (Supreme Court of the United States 1934).
- Process - bankruptcy basics. United States Courts. (n.d.). Retrieved from https://www.uscourts.gov/services-forms/bankruptcy/bankruptcy-basics/process-bankruptcy-basics
- Federal rules of bankruptcy procedure. United States Courts. (n.d.). Retrieved from https://www.uscourts.gov/rules-policies/current-rules-practice-procedure/federal-rules-bankruptcy-procedure
- United States Code. Office of the Law Revision Counsel. (n.d.). Retrieved from https://uscode.house.gov/browse/prelim@title11&edition=prelim
- Cornell Law School. (n.d.). Means test. Legal Information Institute. Retrieved from https://www.law.cornell.edu/wex/means_test
- Discharge in bankruptcy - bankruptcy basics. United States Courts. (n.d.). Retrieved from https://www.uscourts.gov/services-forms/bankruptcy/bankruptcy-basics/discharge-bankruptcy-bankruptcy-basics
- Investopedia. (2021, April 28). What debt can't be discharged when filing for bankruptcy? Investopedia. Retrieved from https://www.investopedia.com/ask/answers/102814/what-debt-cannot-be-discharged-when-filing-bankruptcy.asp
- Weston, L. (2020, September 21). Fear of bankruptcy holds too many people back. AP NEWS. Retrieved from https://apnews.com/article/virus-outbreak-73d65e30c38fff47bc03da7c353e91ed