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What is Bankruptcy?

True Tamplin

Written by True Tamplin, BSc, CEPF®
Updated on July 10, 2021

What Does It Mean to File for Bankruptcy?

Bankruptcy is a legal proceeding in which a debtor declares their inability to pay back their creditors.

The general idea behind declaring bankruptcy is that it allows debtors a “fresh start”while offering creditors a way to receive some or all of their owed payment.

Although some debts are forgiven, filing for bankruptcy affects the debtor’s creditworthiness.

When filing for bankruptcy, secured debts are usually paid for by the asset “securing”the debt, while many types of unsecured debts can be renegotiated.

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What Is Bankruptcy? The Three Chapters of Bankruptcy

There are three common types of bankruptcy known as “chapters”in the U.S. bankruptcy code, Ch. 7, Ch. 11, and Ch. 13, each with varying criteria and consequences.

Ch. 7 Bankruptcy

The most common type of bankruptcy is Chapter 7.

Chapter 7 bankruptcy is known as “straight”or “liquidation”bankruptcy.

It is designed to give a “fresh start”by discharging debts that cannot be repaid through the liquidation of the debtor’s assets.

Upon filing Chapter 7, a trustee is appointed to sell the debtor’s non-exempt assets and distribute the proceeds to creditors.

For individuals, the law exempts certain assets such as retirement funds, primary residence, tools for their trade, and personal vehicles from being liquidated to pay back creditors.

This pays back creditors some of what they are owed and protects individuals from having all of their livelihood taken from them.

Ch. 11 Bankruptcy

Chapter 11 bankruptcy is primarily for companies, allowing them a break on paying their debts in order to restructure, come up with new terms for paying their creditors, and become profitable again.

This allows companies to stay afloat while coming up with a new way to pay back creditors.

Chapter 11 is the most complex and expensive form of a bankruptcy proceeding and should therefore be considered after other options have been explored.

Ch. 13 Bankruptcy

Chapter 13 bankruptcy, known as a “Debtor in Possession”Bankruptcy, stands in contrast with Chapter 7 because it allows the individuals to keep from liquidating their property.

Chapter 13 creates a new, more affordable payment plan for the debtor to repay creditors, usually lasting 3 to 5 years.

Once the payment plan is finished, the remaining unsecured debts are discharged.

Bankruptcy FAQs:

Bankruptcy is a legal proceeding in which a debtor declares their inability to pay back their creditors.
There are three common types of bankruptcy known as “chapters” in the U.S. bankruptcy code, Ch. 7, Ch. 11, and Ch. 13, each with varying criteria and consequences.
A Chapter 7 bankruptcy will stay on your credit report for 10 years, while a Chapter 13 bankruptcy lasts for seven years.
The most common type of bankruptcy is Chapter 7, also known as “straight” or “liquidation” bankruptcy.
The general idea behind declaring bankruptcy is that it allows debtors a “fresh start” while offering creditors a way to receive some or all of their owed payment.

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