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Filing for Bankruptcy: Information, Benefits and Disadvantages

Chad Brooks
Chad Brooks
Editor
Business News Daily Staff
Updated Feb 09, 2022

Once considered a financial death sentence, bankruptcy has become a tunnel to dig out from under mountains of debt.

  • Filing for bankruptcy can have profound financial implications, but debtors sometimes find benefits in the process.
  • There are six types of bankruptcy, and each one applies to specific cases.
  • Once a debtor files for bankruptcy, debt collectors can no longer contact them about owed funds.
  • This article is for business owners and other individuals who want to learn about the benefits and disadvantages of filing for bankruptcy.

Bankruptcy is a legal process by which individuals or businesses publicly declare that they can’t pay all their bills; it’s a way to help them get out from under their debt. Many companies have bounced back from bankruptcy and continued operations after going through the process. 

Bankruptcy laws help people and businesses get a fresh start financially by having their assets liquidated to pay off debts. Alternatively, there may be a repayment plan.

The primary benefit to filing for bankruptcy is that it affords you the opportunity to repay a portion of your debts without collectors breathing down your neck. As soon as you file for bankruptcy, a court order prohibits debt collectors from trying to recoup their money from you on their own for as long as the bankruptcy process lasts.

The Federal Rules of Bankruptcy Procedure and the rules of local bankruptcy courts govern the bankruptcy process. The process is overseen by the U.S. Bankruptcy Court, part of the federal court system. Each of the 94 federal judicial districts handles its own bankruptcy matters. Bankruptcy cases cannot be filed in state court.

We’ll explore bankruptcy types, the pros and cons of filing, and how the bankruptcy process works.

Did you know?Did you know? Debt collection laws govern how and when creditors can contact consumers to recover outstanding debt, but these laws don’t always apply to businesses.

Types of bankruptcy

There are six types of bankruptcy, each named after the chapter that outlines it in the U.S. bankruptcy code.

  • Chapter 7: This process wipes out many of the debts owed while also allowing the liquidation of certain assets to repay some of the obligations.
  • Chapter 9: This is available to municipalities such as cities, towns, villages, counties, taxing districts, municipal utilities and school districts to restructure certain debts.
  • Chapter 11: Debt-riddled businesses often use the Chapter 11 process to keep the venture alive by formulating a plan to pay creditors over time.
  • Chapter 12: This process allows financially troubled family farmers and fishers an opportunity to propose and carry out a plan to repay their debts.
  • Chapter 13: The Chapter 13 process lets those in financial trouble keep their property and pay debts over time, usually three to five years.
  • Chapter 15: This is the most recent addition to the bankruptcy code; it addresses international bankruptcy issues.

TipTip: If you’re considering taking out a debt consolidation loan before going the bankruptcy route, be sure to read the fine print on your existing loans and determine how much you’ll be saving.

Benefits of filing for bankruptcy

Bankruptcy has some notable advantages for those deep in debt.

  • Debt elimination: Most importantly, bankruptcy offers a way to eliminate your debt or develop a firm plan to repay all or some of it. 
  • Protection from legal action: Throughout the bankruptcy process, federal courts protect debtors from any legal action that creditors may try to impose. 
  • Property protection: In some types of bankruptcy, your property is protected from being seized and liquidated. 
  • Discrimination protection: The government provides several protections from discrimination for those who have declared bankruptcy. For instance, businesses can’t fire an employee solely because of a bankruptcy filing.

Disadvantages of filing for bankruptcy

While bankruptcy offers several advantages to cash-strapped individuals and businesses, it isn’t a process to take lightly, as there are also these significant disadvantages. 

  • Ruined credit: The most damning aspect is how bankruptcy ruins your personal or business credit. For up to 10 years after you file, anyone requesting your credit report will be informed of the bankruptcy. This can have long-lasting effects on your ability to buy a car or home, obtain a credit card, or get a bank loan for your business. However, as bankruptcy has become more common in recent years, many creditors no longer immediately disqualify someone because of their history, instead using bankruptcy as just one factor in their decision-making process.
  • Property loss: Another negative to filing for bankruptcy, specifically under Chapter 7 provisions, is that you may lose some or all of your property. If the property is not exempt, it will be sold and used to pay off your outstanding debts. 
  • Career limitations: After filing for bankruptcy, debtors are prohibited from taking on a management role with a limited liability company.
  • Cost: Bankruptcy can cost hundreds or thousands of dollars in legal and court fees, depending on how long the process lasts. 
  • Personal toll: People who file for bankruptcy may feel anguished and embarrassed; the process – and the troubles leading up to it – can leave debtors emotionally scarred.

TipTip: If you’re trying to open a business bank account with bad credit, consider going to a credit union or finding a bank that doesn’t use the ChexSystems consumer behavior monitoring service.

How to file for bankruptcy

Here are the steps in the process of filing for bankruptcy: 

  1. The debtor hires a lawyer. In most cases, you’ll employ an attorney to walk you through the bankruptcy filing process, helping you understand the rules and fill out the proper forms. The necessary forms depend on the type of bankruptcy being filed.
  2. The debtor files the proper forms. To file for bankruptcy, you must use the official bankruptcy forms, currently available on the U.S. Courts website. In addition to over 60 different filing forms you need to sift through, you may need to use several procedural forms.  
  3. The court grants an automatic stay. Once the proper forms have been filed and accepted by the bankruptcy court, an automatic stay is enacted to protect you from collection attempts. 
  4. The debtor takes a financial education course. After the case is filed, you must begin the process of completing a financial education training course.
  5. The debtor meets the creditors in court. The next step is a meeting of creditors, commonly known as a 341 meeting, during which you appear in court to answer questions about your assets and liabilities. 
  6. The trustee determines the assets. Following the meeting, the bankruptcy trustee, who represents the creditors in the case, determines which of your assets will be used to pay off which creditors. 
  7. The trustee issues a discharge recommendation. Once your debts have been settled, the bankruptcy trustee issues a discharge recommendation, meaning you are no longer legally required to pay any debts that are discharged. Once the discharge is official, it’s up to you to start the process of rebuilding your credit.

While businesses must have a lawyer to file a bankruptcy case, individuals have the option of representing themselves in bankruptcy court. However, the courts highly recommend hiring a competent attorney, since the rules are quite complicated, and any mistake can have lasting repercussions – such as the bankruptcy case being thrown out without the option to bring it back again.

Key TakeawayKey takeaway: You’ll file for bankruptcy through the U.S. courts, and the process can involve copious paperwork. A lawyer should be involved.

What to do after filing for bankruptcy

Bankruptcy doesn’t have to be an everlasting burden. There are a few ways to move forward from a bankruptcy filing and start improving your financial state. While these tips can be helpful, you should consult an attorney for professional legal advice.

  1. Check your credit regularly. To ensure your creditors are reporting zero debt balance, check your credit reports regularly. You should also make sure no old debts appear on your reports.
  2. Make a budget. To better manage your finances after bankruptcy, create a budget. Your budget can be a simple table that designates how you will allocate your income to expenses and savings.
  3. Create an emergency fund. These funds can be a lifesaver amid bankruptcy. Your savings should cover three to six months of essential expenses to help you avoid future debt.
  4. Build credit and good financial habits. Whether you’re applying for one of the best business loans or financing a new home, you’ll need good credit. However, improving your credit score can take time. That’s why you should focus on managing your finances, such as by budgeting, saving, and paying your bills on time. You’ll build your credit and some solid financial habits. To confirm that you’re on the right track, check your credit for free once per year through each of the three major credit bureaus. 

Bankruptcy is a complicated and serious process. If you’re considering filing for bankruptcy, carefully weigh the pros and cons to determine if filing is necessary for you to get back on the right financial track.

Shayna Waltower contributed to the writing and research in this article.

Image Credit:

shironosov / Getty Images

Chad Brooks
Chad Brooks
Business News Daily Staff
Chad Brooks is a writer and editor with more than 20 years of media of experience. He has been with Business News Daily and business.com for the past decade, having written and edited content focused specifically on small businesses and entrepreneurship. Chad spearheads coverage of small business communication services, including business phone systems, video conferencing services and conference call solutions. His work has appeared on The Huffington Post, CNBC.com, FoxBusiness.com, Live Science, IT Tech News Daily, Tech News Daily, Security News Daily and Laptop Mag. Chad's first book, How to Start a Home-Based App Development Business, was published in 2014.