What is Bankruptcy?

Bankruptcy is the process where a person legally declares himself or his business unable to pay outstanding debts. Depending upon the type filed, one meets with a judge to determine a payment schedule, or have a legal bankruptcy discharge most if not all debts. Businesses also may declare bankruptcy, which either means the business will close, or that the business will continue to operate with reduced payments to debtors. Each country has its own designations, but this explanation will focus on the most common types in the US.

Bankruptcy for the individual or the married or domestic partner couple comes in three forms, called "Chapters." Chapter 7 is the most common form filed by spouses or individuals. Chapter 12 is restricted to people who are family farmers or fisherman. Individuals or married couples may also file Chapter 13, but this is rare.

For businesses, the two common forms of bankruptcy utilized are Chapter 7 and Chapter 11. Less commonly, an individual or business might file under Chapter 15, which involves the clearing of international debts. If an agency of the state, such as a city, must declare bankruptcy, they file Chapter 9 which is also called municipal bankruptcy.

Chapter 7 tends to be used by either individuals or businesses that want a total clean slate. A business that files Chapter 7 tends to close its doors as a result. For the individual, this type means that the courts declare one unable to pay debts incurred, and almost all debts are then void. Certain federal debts, like student loans, are unaffected by declaring bankruptcy.

One must generally be able to prove that one’s income is insufficient to meet one's debts. A person filing Chapter 7 risks losing the most assets with this type of bankruptcy. One will not lose a primary vehicle or residence under this form, unless the person has an auto loan and cannot make payments on the vehicle, or a home loan, which he or she cannot pay for.

All assets must be declared when filing Chapter 7. Other assets like second houses, collectibles, and additional vehicles are liquidated to pay debts. Most who file Chapter 7 do so because they have very little left to lose. Once a judge approves the filing, virtually all debts, like those owed to credit card companies and doctors or hospitals are cleared and the person is given a clean slate.

Chapter 13 bankruptcy is filed by individuals who do own a great deal of property or assets, but find that their income cannot cover the exorbitant payments on debts owed. In this form, the debt is restructured, and in some cases reduced so that people retain their assets but have reasonable payments which they can make to debtors. Generally the court-ordered payments must be made on time and regularly in order to avoid having assets seized.

Businesses file a similar form called Chapter 11. Some or part of the business' debt may be cleared, and payment plans are restructured. Chapter 11 has the purpose of reorganizing debt so that the business can continue to operate.

All forms are a costly means of gaining debt relief. Both individuals and businesses suffer a reduction of their credit score after a bankruptcy. Individual bankruptcy remains on one’s credit report for 10 years, which can make getting approved for new cars, homes, or credit cards costly and difficult.