Bankruptcy

By:

Arti

Arti is a specialized AI Financial Assistant at Invezz, created to support the editorial team. He leverages both AI and the Invezz.com knowledge base, understands over 100,000... read more.

Reviewed by:

Idil Woodall

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Updated:  May 31, 2024

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4 min read

3 key takeaways

• Bankruptcy provides a fresh start for debtors by either discharging debts or creating a repayment plan.
• There are different types of bankruptcy, each designed for specific situations and needs.
• The bankruptcy process involves several steps, including filing a petition, attending a creditors’ meeting, and complying with court requirements.

What is bankruptcy?

Bankruptcy is a legal proceeding in which a person or business unable to repay outstanding debts seeks relief from some or all of their obligations. It is a process that allows debtors to either eliminate their debts through liquidation (Chapter 7) or create a repayment plan (Chapter 13 or Chapter 11) to pay off debts over time. Bankruptcy aims to provide a fresh financial start while ensuring fair treatment of creditors.

The process is overseen by a bankruptcy court and involves several steps, including the filing of a bankruptcy petition, automatic stay on collection actions, and the eventual discharge or repayment of debts.

Types of bankruptcy

1. Chapter 7 Bankruptcy

• Purpose: Liquidation of assets to repay creditors.
• Eligibility: Individuals or businesses with limited income and assets.
• Process: The bankruptcy trustee sells non-exempt assets and distributes the proceeds to creditors. Remaining eligible debts are discharged.

2. Chapter 13 Bankruptcy

• Purpose: Repayment plan to pay off debts over three to five years.
• Eligibility: Individuals with regular income and unsecured debts below a certain threshold.
• Process: The debtor proposes a repayment plan, which must be approved by the court. The debtor makes regular payments to a trustee, who distributes the funds to creditors.

3. Chapter 11 Bankruptcy

• Purpose: Reorganization of debts for businesses and individuals with substantial debts.
• Eligibility: Primarily used by businesses, but individuals can also file.
• Process: The debtor continues to operate the business while proposing a plan to restructure and repay debts. Creditors may vote on the plan, and the court must approve it.

Steps in the bankruptcy process

1. Credit counseling: Before filing for bankruptcy, debtors must complete a credit counseling course from an approved agency.
2. Filing the petition: The debtor files a bankruptcy petition with the court, including detailed financial information.
3. Automatic stay: Upon filing, an automatic stay is issued, halting most collection actions against the debtor.
4. Meeting of creditors (341 meeting): The debtor must attend a meeting where creditors can ask questions about their financial affairs.
5. Asset liquidation or repayment plan: Depending on the type of bankruptcy, the trustee will either liquidate non-exempt assets or oversee the repayment plan.
6. Discharge or completion: In Chapter 7, eligible debts are discharged after asset liquidation. In Chapter 13, debts are discharged after the repayment plan is completed.

Benefits of bankruptcy

• Debt relief: Bankruptcy can discharge or reduce debts, providing financial relief.
• Fresh start: Allows individuals and businesses to rebuild their financial stability.
• Protection: The automatic stay protects debtors from creditor harassment and collection actions during the process.

Real-world application

Example: Jane, burdened by credit card debt and medical bills, decides to file for Chapter 7 bankruptcy.

Credit counseling: Jane completes the required credit counseling course.

Filing the petition: Jane files a bankruptcy petition, listing all her debts, assets, income, and expenses.

Automatic stay: The court issues an automatic stay, stopping creditors from pursuing collection actions.

Meeting of creditors: Jane attends the 341 meeting, where the trustee and creditors ask questions about her financial situation.

Asset liquidation: The trustee identifies non-exempt assets, such as a second car, and sells them to repay creditors.

Discharge: After the liquidation process, the court discharges Jane’s remaining eligible debts, providing her with a fresh financial start.