Table of Contents

    What Is Bankruptcy?

    Bankruptcy is a legal process undertaken by a firm or an individual to relieve themselves from debts, while providing creditors with an opportunity to obtain a portion of the repayment. The filing procedure varies depending on the situation and applicable chapter of the code selected. 

    In the US, all such hearings are handled by federal courts. The legal proceeding can be lengthy and costly depending on the type of filing. That said, bear in mind that filing for bankruptcy will affect your credit score and might prevent you from accessing new financing in the immediate future. 

    How Does Bankruptcy Work?

    When you file for bankruptcy, your debt might either be reduced, restructured, or waived off in full. You need to go through the federal court system to be approved for this type of debt discharge. Here’s how it works:

    • Start by compiling all of your financial records.
    • Obtain credit counselling services from an approved provider at least 180 days before filing.
    • Collect the certification of completion and submit it alongside the application.
    • Select the appropriate chapter under which you wish to file bankruptcy.
    • Next, file the petition on your own or hire a lawyer.
    • Fill out all the required forms and present yourself on the date provided by the court.
    • Depending on your situation, the judge will deliver a verdict.

    Types of Bankruptcy

    As briefly mentioned above, filing bankruptcy in the US may fall under one of several federally approved chapters. Listed below are the details:

    1. Liquidation (Chapter 7) - This type of proceeding involves selling assets or liquidation to pay off outstanding debts and remove all financial obligations. The value of the assets owned by the individual or the company plays a significant role here.
    2. Substantial Reorganization (Chapter 11) - Chapter 11 implies that an organization will work towards reorganizing and rebuilding in order to repay their outstanding monetary commitments. This specific liquidation process is generally meant for organizations/firms and not for ordinary people. It gives them the opportunity to stay in business while attempting to take care of the outstanding debts.
    3. Wage Earner’s Plan (Chapter 13) - If you make enough money to be ineligible for Chapter 7, you may try filing under Chapter 13. It is also known as a wage earner’s plan. Under this, individuals and businesses able to demonstrate stable income can request workable repayment plans across three to five year periods. This option can be especially helpful for addressing the reasons for personal bankruptcy.

    Although these three are the most commonly used chapters for individuals, Federal Law also offers other options primarily aimed at businesses:

    1. Chapter 9 - Available for cities, towns, and counties with proven financial hardship wherein they are allowed to create a payment plan rather than liquidating the assets.
    2. Chapter 12 - Available for fisheries and farms whereby borrowers are allowed to request manageable repayment plans while continuing to operate businesses.
    3. Chapter 15 - This was added in 2005 and deals with cross-border cases.

    Debt Discharge

    When a borrower receives the discharge order, they’re legally free to pay off the debt. The creditors cannot pursue further collection activities once the order is in force. However, it is important to understand that not all debts qualify for discharge. For instance, child support, tax claims, alimony, and debts owed to the government along with several others do not qualify for discharge. Moreover, in the case of secured loans, the lender has a legal right to enforce a lien against the collateral, provided the lien is still valid.

    Once a borrower files a claim, the court sends a notice to creditors. The creditors have the legal right to object this notice and file a complaint before the deadline. In general, a debt discharge filed under Chapter 7 of the US Bankruptcy Code is granted about four months after the petition is filed. For all other types, the discharge may be offered when the court deems it practical.

    Pros Vs Cons Of Bankruptcy

    Pros:

    • Filing ensures immediate hold on all collection activities pursued by the lenders. This stay can also delay certain actions like forced foreclosure or repossession.
    • Although some of your assets may be liquidated under Chapter 7 filing, you’ll still end up keeping a larger portion of the assets including your car and home.
    • You’ll be relieved of most debts. Even if you don’t receive a complete debt discharge, you’ll no longer be required to repay all of the debts in full.
    • You can be eligible for debt repayment programs under Chapter 13.

    Cons:

    • Your credit score will take a massive hit which will be reflected on a credit report.
    • You’ll face difficulties receiving approval for new loans and cards.
    • During the liquidation process, you’ll face loss of assets.
    • You won’t be eligible for tax exemptions or refunds.
    • Even if you file bankruptcy, not all debts are eligible for discharge.

    Bottom Line 

    If your credit score is heavily damaged and your finances are dwindling, bankruptcy is a last resort. However, bear in mind the fact that not all debts are dischargeable with this type  of debt relief. 

    If you decide to file your petition, make sure to seek assistance from a qualified lawyer, select the right chapter, and follow the proper legal procedures. Above all, be informed that a discharge will be visible on your credit report for seven to ten years. Hence, take time to determine if this is the right choice for you.