Types of Bankruptcy

Bankruptcy doesn't always mean a person is completely wiped out or a company is out of business. In fact, increasingly, the opposite is usually true. Bankruptcy is a branch of law with many types, all of which seek to help debtors get out from unbearable debt and help creditors recover as much of their money as possible. In the process, both sides usually make some compromises.

Features

The purpose of bankruptcy is to take what seems like an impossible situation, more debt than can be paid, and find a workable solution for all involved. For debtors this can mean restructuring the terms and payments on debt, or forgiveness of debt altogether. Creditors can benefit from bankruptcy because it clarifies the debtor's financial situation and can provide for a greater level payment of repayment than might otherwise have been realized. In all cases, the principal feature of bankruptcy is the mitigation by a court between a debtor and their creditors.

Types

The U.S. Constitution puts bankruptcy under federal jurisdiction, and the U.S. Code contemplates several types of bankruptcy based on the condition and nature of the debtor. Specific consideration is made for individuals, corporations, municipalities, family farms, fishermen, and international entities. Two types of bankruptcy relief are generally available, liquidation and debt restructuring.

Features

Liquidation is usually carried out under chapter 7. In this process, a court appointed trustee sells or otherwise values all of a debtor's nonexempt assets, which vary widely by state, and pays creditors to the degree possible. With some exceptions, the remainder of the debt is forgiven. Debt restructuring, on the other hand, is an attempt to lower interest rates or monthly payments, and occasionally the principal, to allow a debtor to make good on their obligations. Restructuring is done under chapter 11 for corporations, chapter 13 for individuals, chapter 9 for municipalities, chapter 12 for farmers, and chapter 15 for international entities.

Considerations

Prior to the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005, most individuals sought chapter 7 bankruptcy and the discharge of their debts. The law modified eligibility chapter 7 liquidation by requiring a means test for anyone earning above the median income in their state. Petitioners are disqualified from chapter 7 if their monthly income is above $166 after subtracting certain expenses such as clothing, transportation, food and payments on mortgages, cars, child support, alimony, or back taxes.

Significance

The chapter 7 means test sends more individual filers to restructure their debt under chapter 13, to the benefit of the creditors. Most corporations and municipalities already prefer to restructure their debt rather than liquidate because they are often worth more as a going concern and, in the case of a city, there is usually at least some guaranteed future income due to its tax base.

Resources

• Bankruptcy