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Bankruptcy is a federally authorized procedure where a debtor is legally relieved of total liability for its debts by making court-approved arrangements for their partial repayment. A debtor may be an individual, corporation, or municipality. The goal of modern bankruptcy is to allow the debtor to have a new start on their finances by coming to an agreement with creditors on an amount to be repaid. Bankruptcy in America (and all over the world for that matter) is not uncommon. For the Fiscal year 2012, 1,261,140 bankruptcies were filed, which was a decrease of 11% from the prior fiscal year of 2011(S1).
Historically, bankruptcy was looked down upon and considered a shameful resort to handle debts. Starting as early as the eighteenth century, courts began to change their views on those seeking bankruptcy by recognizing that they needed help and were willing to fix their financial state. The United States Government attempted to settle on a reasonable act for those needing to file for bankruptcy for over a hundred years, starting with the first Bankruptcy Act of 1800. Four acts were passed and revised since then, bringing debtors their current act, known as The Bankruptcy Code (S2).
Filing for bankruptcy will take a hit to your credit score, but how much depends on your credit profile as a whole, the type of bankruptcy, and how many accounts are included in the filing of bankruptcy. If you’re considering filing for bankruptcy, you should first know what you should file for and the differences between the chapters.
Chapter 7-This is an option for liquidation, and should only be considered as a last alternative. Those who may file for Chapter 7 include individuals, corporations, partnerships, or other business entities. In this situation there is no repayment plan in place and the bankruptcy trustee gathers and sells the debtor’s nonexempt assets. The proceeds of the sold assets are used to pay creditors in accordance with the Bankruptcy Code. Some property owned by the debtor may be subject to liens and mortgages that pledge the property to other creditors. Filing for Chapter 7 may result in loss of property, with the exception of certain exempt properties (S1).
Chapter 9- Those who should file for this kind of bankruptcy include municipalities. Similar to Chapter 11 and also called municipality bankruptcy, this allows the reorganization of municipalities. “Municipalities” include villages, cities, towns, counties, districts, school districts, and municipal utilities. Chapter 9 allows municipalities that are financially-distressed to be protected from their creditors while developing and negotiating a plan for adjusting debts. Reorganization is usually accomplished by extending debt maturities, refinancing the debt by obtaining a new loan and terms, or by reducing the amount of principal or interest. This tends to be the least common in filed petitions (S1).
Chapter 11- This type of bankruptcy involves a corporation or partnership where the debtor creates a plan of reorganization to keep the business from closing and pay creditors over time. Sometimes a Chapter 11 plan can mean the liquidation of your assets, but that’s more common for Chapter 7. Filing for Chapter 11 begins with a petition that’s submitted voluntarily by the debtor or creditor(s). A United States Trustee plays a major role in this type of filing by monitoring the progress and supervising its administration (S1).
Chapter 12- This was designed for a “family farmer” or “family fisherman” that brings in a regular income. This is similar to Chapter 13, in that the debtor may propose a repayment plan to repay all or part of their debt over the course of three to five years. The plan may not exceed five years and during that time period, debtors may not continue to try to collect debts. This type of petition has less barriers than Chapter 11 or 13, is more streamlined, less complicated, and less expensive (S1).
Chapter 13- Also called a wage earner’s plan, this enables individuals with regular income to come up with a reasonable plan to repay all or part of their debts. The time frame to repay these debts is three or five years, depending on the debtor’s monthly income. The plan may not exceed five years. During that time period, debtors may not continue to try to collect debts. Individuals can save their homes from foreclosure, reschedule secured debts, and may even lower certain payments (S1).
Chapter 15- This is the newest chapter, added in 2005 by the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005. This was developed to provide effective mechanisms for dealing with insolvency cases involving debtors, claimants, assets, and other parties of interest involving more than one country. Generally speaking, a Chapter 15 case provides support to a primary proceeding brought in another country, usually the debtor’s home country. This kind of bankruptcy can get pretty complex with the cooperation of foreign countries and their policies (S1).
Bankruptcy is a very complex web of rules, filings, and regulations, so the above terms are defined simplistically and covers only general ideas.