If an individual or business is unable to pay their expenses to their creditors then they may legally declare that inability in an action known as bankruptcy. Individuals can file for personal bankruptcy while businesses and corporations can file for business bankruptcy.
Certain types of bankruptcy can allow the party a clean slate with their financial problems; to more or less start over with expenses, bills, etc. This is done through the discharging of certain debts the party owes, as well as setting up a payment plan for those debts that cannot be discharged. Also, bankruptcy can allow for what’s known as an automatic stay, which gives the party a temporary period of time during which creditors cannot collect on debts owed. However, there are ways for creditors to dodge this hiatus, so it’s important to know how and when the automatic stay is effective, and what risks are involved.
There are several kinds of bankruptcy, depending on the party involved, their debts accrued, available income, and in some cases, personal choice. The most common are Chapter 7, Chapter 13, and Chapter 11.
Chapter 7 is a form of bankruptcy also known as liquidation. When a party files for Chapter 7 bankruptcy all of their assets are sold off and the resulting funds are used to pay off debts owed to creditors. Often, an individual filing for Chapter 7 will lose their home, but this typically large payment will help them establish the “clean slate” circumstances mentioned above, and all their debt will be discharged. If a business files for Chapter 7 they must shut down production immediately. Generally, those filing for Chapter 7 lack an income sufficient to pay off creditors in a reasonable amount of time while supporting themselves and their family. This eligibility for Chapter 7 is established through a “means test”, in which the party’s monthly income is averaged from the past six months, and then compared to the median income of similar households in the state. If the income is less than this median, then the debtor qualifies for Chapter 7.
There are several items that are exempt from liquidation during bankruptcy, the general rule of thumb being if it’s necessary, it’s usually exempt. These items include automobiles under a certain monetary value, household appliances, necessary clothing, jewelry under a certain monetary value, pensions, necessary furniture, tools of the debtor’s trade, and earned wages that have not yet been paid to the debtor.
Chapter 13 is for those persons or businesses with an above-average income from the past six months, or will have larger income in the immediate future, and is also known as a wage-earner’s plan. With this plan only a few or no debts are discharged, and the party pays back their creditors over a period of years. While you are required to pay your debts in this situation, you do not have to sell off your property and potentially lose your home, as with Chapter 7. If your income does not meet the standards for Chapter 13 you will not be able to file, since this is largely based on your ability to pay your debts. A payment plan is laid out according to how much you owe, your income, when you can realistically make payments, and how large those payments can be.
Like Chapter 13, Chapter 11 is a form of bankruptcy filed by entities with a foreseeable income and ability to pay debts, but it is typically employed by businesses. A payment plan is decided upon, and the business gradually pays off their debts. Also, due to the payment plan stipulation, the business is typically allowed to stay open, unlike Chapter 7. Chapter 11 bankruptcy is also known as restructuring or reorganization.
There are several types of debt a person or business can accrue, not all of which are dischargeable through bankruptcy. Those not dischargeable are government tax claims, spousal and child support, customs fees, fines owed for convicted crimes, student loans, and secured debt. A secured debt is a debt owed to a creditor which is “secured” by a promised collateral item should the debtor not be able to pay. If this is the case the item or items are surrendered to the creditor as an alternative to a monetary payment.
Debts that are dischargeable through bankruptcy are utility payments (electric, water, etc.), credit card payments, medical bills, legal and accounting payments, personal loans, and unsecured debt. Unsecured debt is a payment owed that is not “secured” by a collateral item.
There is much to think about before deciding to file for bankruptcy. First of all, you must find out if you are actually eligible, and if so, for what kind of bankruptcy. You should consider: are your debts severe enough to file for bankruptcy? Also, this is where the means test will come in handy in establishing which chapter of bankruptcy to file. You also may wish to examine what kind of debts you owe; if they cannot be discharged through bankruptcy, such as student loans, you may wish to forgo filing for bankruptcy if possible. If you fall below the median monthly income level in the means test you may wish to reconsider bankruptcy as well, since this most likely will result in the loss of your home. The desire to avoid creditors is not always a good reason to file for bankruptcy either; though the automatic stay can prevent some creditors from hassling you with attempts to collect payments, they can often take the matter to court and get around the staying order. Finally, one of the most important questions to ask yourself is if you will be better off after filing for bankruptcy. Sometimes bankruptcy can put you into an even more severe financial situation than before, so it’s important to consider the consequences and alternatives.