Bankruptcy is a financial concept you need to understand. Bankrate explains.

What is bankruptcy?

Bankruptcy, also known as insolvancy, is the legal status of people, businesses, and governments that have more debt than they are able to pay. Bankruptcy also describes the process of resolving a situation where a debtor has an unsustainable level of debt, protected from creditors by a bankruptcy court. Title 11 of the United States Code outlines the various forms of bankruptcy available in the U.S.

Deeper definition

The bankruptcy process offers both creditors and debtors the chance to resolve liabilities that cannot be paid. In exchange for debt forgiveness, debtors place their assets under control of a bankruptcy court and agree to give up most or all of their wealth in repayment, while creditors get the chance to see at least some of their loans repaid. Bankruptcy aids the broader economy by giving people a second chance to start again, instead of burdening them permanently with unpayable debts.

When you file for bankruptcy, creditors are prevented from taking legal action to collect money you owe them. Filing for bankruptcy prevents or delays repossessions, foreclosures, and wage garnishment. It also carries negative financial consequences that affect petitioners for years. A Chapter 7 bankruptcy appears on credit reports for 10 years, and a Chapter 13 bankruptcy appears for seven years. Loans become very hard to obtain, insurance premiums may rise, and landlords may refuse rental applications.

U.S. law contains provisions for several types of bankruptcy, called chapters. Chapter 7 allows businesses and individuals to liquidate all their assets to pay outstanding debts. Chapter 13 bankruptcy is an option for people who have a reliable source of income and the ability to pay back their debts. Chapter 11 is a very restrictive form of reorganization. Chapter 9 deals specifically with municipal entities, such as utility companies, school districts, and cities.

Could a home equity loan help you avoid bankruptcy? Compare home equity rates.

Bankruptcy example

The fall of Enron Corporation ranks as one of the most notorious bankruptcies in history. Enron began in 1985 as a pipeline company through the merger two smaller firms. The company rapidly moved into new fields, and became a major player in commodities trading. By 2000, the company’s annual revenue reached $100 billion, making it the sixth-largest energy company in the world.

Cracks began to appear in Enron’s business by 2001 as the tech bubble burst, financing became more expensive and accounting scandals were exposed in which the company used various dubious practices to hide billions in debt from failed deals and unsuccessful projects. In October 2001, Enron reported a huge quarterly loss of $618 million, and by late November the company’s stock had fallen to less than $1 from a peak around $90.

On Dec. 2, 2001, Enron filed for Chapter 11 bankruptcy protection, with an estimated $23 billion in liabilities from both debt outstanding and guaranteed loans. This figured ballooned to $67 billion in liabilities. Public shareholders were wiped out, and Enron’s employees lost their pensions.


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