Once considered a financial death sentence, bankruptcy has become a path to digging out from under mountains of debt.
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Bankruptcy is a legal process by which individuals or businesses can publically declare that they are unable to pay all their bills, as a way to help them get out from under their debt. Bankruptcy laws help people and businesses get a fresh start financially by having their assets liquidated in order to pay off their debts, or by creating a repayment plan.
The major benefit to filing for bankruptcy is that it affords those who file the opportunity to repay a portion of their debts without collectors breathing down their neck. As soon as an individual or business files for bankruptcy, a court order is instilled that prohibits debt collectors from trying to recoup their money on their own for as long as the bankruptcy process lasts.
The Federal Rules of Bankruptcy Procedure and local rules of each bankruptcy court govern the bankruptcy process. The process is overseen by the Bankruptcy Court, which is part of the U.S. courts system. Each of the 94 different federal judicial districts handles its own bankruptcy matters.Bankruptcy cases cannot be filed in state court.
Types of bankruptcy
There are six types of bankruptcy, each named after the chapter that outlines it in the U.S. Bankruptcy Code. The six different bankruptcy types are:
- Chapter 7: This process wipes out many of the debts owed, but also allows the liquidation of certain assets in order to repay some of the obligations.
- Chapter 9: Available to municipalities such as cities, towns, villages, counties, taxing districts, municipal utilities and school districts as way to restructure certain debts.
- Chapter 11: Often used by debt-riddled businesses as a way to keep the venture alive by coming up with a plan to pay creditors over time.
- Chapter 12: Allows financially troubled family farmers and fishermen an opportunity to propose and carry out a plan to repay their debts.
- Chapter 13: Lets those in financial trouble keep their property and pay debts over time, usually three to five years.
- Chapter 15: The most recent addition to the Bankruptcy Code, it addresses international bankruptcy issues.
Benefits and disadvantages of bankruptcy
While bankruptcy offers a number of advantages to cash-strapped individuals and businesses, it isn't a process that can be taken lightly. While there are some benefits to filing for bankruptcy, there are also numerous disadvantages. The most damning aspect is that it ruins the debtor's credit. For up to 10 years after the filing, anyone requesting a credit report on the debtor will be informed of the bankruptcy. This can have long-lasting effects on the ability to buy a car or home, obtain a credit card or get a loan. However, as bankruptcy has become more common in recent years, many creditors are no longer immediately disqualifying someone because of their past history, and only use bankruptcy as one aspect in their decision-making process.
Another negative to filing for bankruptcy, specifically under Chapter 7 provisions, is that the debtor may lose some or all of their property. If the property is not exempt, it will be sold and used to pay off the outstanding debts. Additionally, after filing for bankruptcy, debtors are prohibited from taking on a management role with a limited liability company – and it can cost hundreds or thousands of dollars in legal and court fees, depending on how long the process lasts. Finally, the embarrassment of having to file for bankruptcy often leaves debtors emotionally scarred.
Despite the drawbacks, individuals and businesses often find many benefits for going through bankruptcy. Most importantly, it offers a way to eliminate the debt owed or come up with a set plan on how to repay all or some of it. Throughout the process, debtors are protected by the federal courts from any legal action that creditors may try to impose. Also, in some types of bankruptcy, a debtor's property is protected from being seized and liquidated. The government also provides those who have filed for bankruptcy several protections from discrimination. Employers, for instance, can't fire an employee solely because of a bankruptcy filing.
How to file for bankruptcy
In most cases, a debtor will employ an attorney to walk them through the bankruptcy filing process by helping them understand the rules and regulations and assisting them in filling out the proper forms, which differ based on the type of bankruptcy being filed, as set forth by the U.S. Courts.
To file for bankruptcy, debtors must use the Official Bankruptcy Forms, which are currently available on the U.S. Courts website. In addition to the more than 60 different filing forms that debtors need to sift through, there are a number of procedural forms that may need to be used as well. Once the proper forms have been filed and accepted by the bankruptcy court, an automatic stay is enacted, protecting the debtor from collection attempts. After the case is filed, debtors must begin the process of completing a financial education training course.
The next step is a meeting of creditors, commonly known as a "341 Meeting," during which the debtor appears in court to answer questions about their assets and liabilities. Following the meeting, the bankruptcy trustee, who represents the creditors during the case, determines which assets will be used to pay off which creditors. Once the debts have been settled, the bankruptcy trustee issues a discharge recommendation, meaning the debtor is no longer legally required to pay any debts that are discharged. Once the discharge is official, it is up to the debtor to start the process of rebuilding credit.
While businesses must have a lawyer to file a bankruptcy case, individuals have the option of representing themselves in bankruptcy court. However, the U.S. court system highly recommends hiring a competent attorney, since the rules are quite complicated and any mistake can have lasting repercussions, including the possibility of having the bankruptcy case thrown out without the option to bring it back again.
Overall, bankruptcy is a complicated and serious process. Those considering filing for bankruptcy should carefully weigh the pros and cons to determine if this is what's needed to get on the right financial footing.