Bankruptcy is typically seen as a last resort when debt has become unmanageable. But while it can have negative effects, bankruptcy exists to give debtors a fresh financial start.
The bankruptcy code allows individuals, municipalities and corporations to reorganize their debts or have them discharged entirely. The Administrative Office of the U.S. Courts says that 612,561 people and businesses filed bankruptcy in the 12 months ending Sept. 30, 2020. Here’s a look at what this code covers.
Types of bankruptcy under the US bankruptcy code
When a debtor faces serious debt problems, one option is to file bankruptcy. When filed, bankruptcy can stop some creditors from seeking damages against the debtor in court, discharge some debts and allow debtors to get a fresh start, free from the burden of debt they can’t pay back.
Bankruptcy law also places restrictions on how often debtors can file. This is necessary to keep debtors, or people that owe money, from taking advantage of the system. Other restrictions include meeting certain income-level requirements and proving in a court of law that the debt accrued can’t be paid.
Depending on whether the debtor is an individual, business or municipality, different chapters of the bankruptcy code apply to the debtor.
- Chapter 7: Chapter 7 bankruptcy is available to businesses and consumers looking to clear away certain unsecured debts, such as credit card balances. When filing Chapter 7, you will be assigned a trustee, who will review your finances, sell your assets and distribute the proceeds to your creditors. At the end of the process, the court may discharge the rest of your debts. In order to qualify for a Chapter 7 bankruptcy, the debtor’s income level must not exceed a certain amount, as set by individual states.
- Chapter 9: Financially distressed municipalities can use Chapter 9 bankruptcy to restructure their debts without selling off their assets. The law applies to eligible cities and towns, counties, taxing districts, revenue-producing bodies such as highway authorities, municipal utilities and school districts. It does not apply to state governments. Once the locality files the bankruptcy petition, they create a plan to pay back their creditors. Reorganization plans normally involve extending debt repayment deadlines, reducing the amount of principal or interest or refinancing the debt via a new loan.
- Chapter 11: This type of bankruptcy allows corporations or partnerships to reorganize their debts. A Chapter 11 bankruptcy debtor proposes a plan for reorganization and promises to repay the debt over time. In the meantime, the debtor can continue to operate their business as usual.
- Chapter 12: If you have a family farm or fishing business, you can use a Chapter 12 bankruptcy to reorganize your debts through a payment plan. You must have a regular annual income, and the bulk of your debts must be related to the farming or fishing business. As you follow the plan to pay down debt, you can continue operating your business.
- Chapter 13: Debtors who don’t meet the eligibility requirements of Chapter 7 may file for Chapter 13 bankruptcy. This type of bankruptcy allows debtors to keep certain assets, such as their home or car. It’s known as a “wage earner’s plan” because you use your income to repay some or all of your debts over the course of three to five years. At the end of that period, the court will discharge most of your remaining debts.
- Chapter 15: This chapter of the bankruptcy code deals specifically with debt incurred in a country other than the U.S. A Chapter 15 bankruptcy provides the mechanism by which such cross-border cases are handled in the U.S. court system.
In a bankruptcy case, a debtor files the appropriate bankruptcy in the court where the case is brought for review. The judge overseeing the bankruptcy then determines if the debtor qualifies for the bankruptcy and what actions, if any, the debtor needs to take. Certain debts, such as any taxes owed, child support and student loans are not eligible for discharge as part of a bankruptcy.
The bottom line
Chapter 7 and Chapter 13 are the most common forms of consumer bankruptcy. If you feel overwhelmed with debt, you can’t afford to pay for basic necessities and you’re avoiding calls from debt collectors, you might consider this route.
Before filing for bankruptcy protection, however, you should understand how this decision will impact your credit. A bankruptcy filing can remain on your credit reports for up to 10 years from the date you file the petition and could lower your credit score by around 130 to 200 points.
Consider talking with a credit counselor, who can review your finances and help you understand your options. Together, you can piece together a plan.