There is a common notion that bankruptcy spells doom for companies who file. While it is true that only businesses and individuals who are in trouble file for bankruptcy, it does not exactly mean the end. It can instead be one option they take to make sure they survive.
Most people do not understand the whole concept of bankruptcy. It would be wise to know what filing for bankruptcy could mean for you and how it can help you get back to your feet, just in case.
I. What is bankruptcy?
According to Wikipedia, bankruptcy is a legal process wherein an individual or organization is no longer able to repay debts to lenders and has sought relief for some or all of their debts. Typically, a debtor initiates bankruptcy and a court order imposes it.
So if you or your business are being tormented by bill collectors, have enormous liabilities that you cannot pay back, are behind in your mortgage payments, and are near foreclosure, then declaring bankruptcy might be the solution to your problems.
Bankruptcy should not be confused with insolvency.
II. Bankruptcy types
There are six types of bankruptcy, but the most common ones are Chapters 7, 11, and 13. For this article, we will discuss only these three.
- Chapter 7
Chapter 7 controls the procedures in asset liquidation and permits liquidation of assets as payment for debts. A bankruptcy trustee liquidates nonexempt assets to pay lenders. When all the proceeds are spent, the unpaid debts are discharged.
There is a stipulation in Chapter 7 that outlines the order in which the borrower will pay the creditors. Unsecured debts are divided into categories, with each category having priority for payment.
The trustee will oversee the payment of unsecured priority debts first. Some examples of this type of debt are child support, tax debts, and personal injury claims against the borrower if any.
There are also secured debts, which are debts that are secured by collateral. Collateral reduces the risk related to lending.
Next, they pay secured debts. After all secured debts have been paid, they then pay nonpriority, unsecured debts with what is left of the funds after the assets are liquidated.
In case the funds are no longer sufficient to pay for the remaining debts, the debtor will still pay the debts but on a pro-rated basis.
- Chapter 13
The debtor is required to report all creditors and the amount of money owed to each one. The debtor is also expected to document all property owned, income information, and a detail of monthly expenses.
After all the lists, the debtor will agree on a monthly payment to an appointed bankruptcy trustee who will then consolidate all payments as well as the debts into a monthly amount. It is the job of the trustee then to distribute the funds to all the listed creditors. Debtors do not speak with the lenders under Chapter 13 protection.
There is a certain amount of debt required before a person can qualify for Chapter 13. For unsecured debts, the limit is $419,275, while for secured debt it is $1,257,850. Debtors are also required to take credit counseling as part of the requirements to qualify.
- Chapter 11
Chapter 11 bankruptcy is the most publicized of them all simply because it is mainly for businesses. It involves a restructuring of a debtor’s business, debts, and assets.
Companies file for Chapter 11 bankruptcy if they need time to reorganize their debts. Chapter 11 can help give companies a new lease on life, though the terms depend on how the debtors would be able to fulfill its responsibilities under the plan of restructuring.
Chapter 11 is the most complicated and most expensive of all types of bankruptcy proceedings. That is why a business should file for Chapter 11 only after exhausting other options and with a careful analysis of their situation.
A court will assist a company to reorganize its debts and obligations. Most of the time the company continues to operate. Many large U.S. corporations have filed for bankruptcy and have recovered. Some even became stronger than before they went bankrupt.
III. The Bankruptcy process
- Counseling and filling out forms
Those who wish to file for bankruptcy need to go through credit counseling. After counseling, the applicant is required to complete many forms to jumpstart the official proceedings.
The forms are very detailed. Filers need to give their personal information like finances, assets, income, creditors, and expenses. After filing, the creditors will be prevented from collecting their debt. This process is called an automatic stay.
- Trustee appointment and meeting with creditors
The court handling the bankruptcy case will appoint an unbiased trustee to see through all of the proceedings. The trustee will study the assets and choose which ones to sell so that they can pay the creditors.
After liquidating the assets, the trustee would then set up a meeting with creditors to confirm the validity of finances and petition. This meeting is where the debtor and creditors meet to negotiate.
- Repayment of debt
The trustee reviews all the personal finances and assets of the debtor. The law assures that the debtor should still be able to maintain basic standards of living, so there are properties exempted from the liquidation process. Properties that are not exempted are seized and are up for liquidation.
Exempt properties are different for each state. Most of the time, the debtor gets to keep his primary home, car, and personal belongings.
- Discharge of remaining debt
Under Chapter 7 bankruptcy, most debts are discharged. This will release the debtor from any obligation to pay.
Child support, alimony, income taxes, federal student loans, and some government debts are not included in the discharge during bankruptcy. The U.S. Bankruptcy Code lists 19 categories of debt that are not allowed for discharge.
Before discharge of remaining debt, the filer needs to take a debtor education course. This course will advise on money management and budgeting. The filer will get a certificate after the course, which is part of the requirements.
IV. Bankruptcy consequences
Both Chapter 7 and Chapter 13 bankruptcy have negative consequences.
Chapter 7 bankruptcy will be on your record for ten years. Chapter 13 bankruptcy, on the other hand, will remain on your record for seven years.
Declaring bankruptcy will make you look like a risk to businesses that would want to look at your credit score. These companies may include insurance companies, lenders, potential employers, and banks.
Bankruptcy may not be for everyone, and it may or may not be for you. Before filing for bankruptcy in case the need arises, consider other options first. If you are in financial woe, do not panic. Maybe you just need a few simple adjustments to remedy the situation.
You can go to your creditors and renegotiate your terms. Most creditors are willing to listen if you only ask. They would rather receive payment later or in part rather than not receiving anything at all.
For mortgage payments, you can try calling your loan servicer to find out what options you have. A forbearance, or stopping payments for a specific period, may be an option. A loan modification may be another, which would change the term of your loan permanently.
Bankruptcy is a life-changing event. If you are considering bankruptcy, it means you are most probably dealing with complex financial problems.
Bankruptcy law serves to help people who have an unmanageable amount of debt through no fault of their own. They might have incurred large medical bills or other unexpected expenses.
Bankruptcy allows both individuals and businesses to make a fresh start. But it is not a simple process and does not always lead to the desired result by the filer.
Before filing for bankruptcy, make sure to exhaust all other alternatives that would have lesser implications on your future. Keep in mind that once you file for bankruptcy, it will be on your records for years.
Another thing is that bankruptcy is highly preventable. By managing your finances carefully and paying bills on time, you would never even have to think about bankruptcy at all.