When an individual files for bankruptcy, he/she is essentially appealing to a federal court and claiming that he/she is unable to repay a significant amount of outstanding debts; the goal for the debtor is to have as many debts discharged as possible (a “discharged debt” being one that the debtor will not have to pay back, or will only have to pay a small portion of the debt to the lender before the outstanding balance is wiped clean). Lenders obviously do not like bankruptcy cases, because it’s likely that they won’t be able to collect the full amount of debt still owed. Bankruptcy cases are quite complicated, mostly because there are such huge amounts of debts that need to be paid, transferred, or forgiven.
The U.S. is divided into 90 bankruptcy districts, with each state having at least one district. Each bankruptcy case is evaluated and presided over by a bankruptcy judge, who delivers the final decision regarding whether the debtor should be allowed a discharge of debt, and how much that discharge will be.
There are six different chapters of bankruptcy filings, and personal circumstances determine which chapter you’d file. We’re going to look at the most common types of bankruptcy that individuals would have to consider when filing for bankruptcy, although there are four more types of bankruptcy that apply to organizations and municipalities (Chapters 9, 11, 12, and 15). When a company or municipality files for bankruptcy, the circumstances are usually quite different from those that surround individuals struggling with debt, and the filing process is significantly more complicated.
That being said, let’s take a look at the two types of bankruptcy that you may be considering if you’re currently struggling with debts.
Chapter 7: Liquidation
This type of bankruptcy involves liquidating (selling) all assets to pay off outstanding debts. The court assigns a trustee to help the debtor liquidate all available assets, and this supervision is intended to ensure that the entire process is in compliance with the agreed-upon court regulations.
Occasionally, a debtor will possess certain properties that are exempt from liquidation, and the trustee makes sure that these properties are not confiscated. In most cases, however, the debtor doesn’t have enough assets to pay off the debt entirely. In these cases, a court will decide whether the remaining debts can be discharged.
Individual debtors usually file for Chapter 7 bankruptcy, but in certain cases, the individual possesses too many debts that cannot be discharged, and a Chapter 13 bankruptcy is the better choice.
Chapter 13: Restructuring of Debts of an Individual with Regular Income
Anyone who possesses too many debts that cannot be discharged, and is therefore unable to file for Chapter 7 bankruptcy, will be directed to Chapter 13. Debtors often turn to Chapter 13 because they have fallen behind on taxes, or because they have defaulted mortgage and/or car payments. Interestingly enough, this type of bankruptcy is becoming more popular in recent years because student loans -- which have risen exponentially in the past couple of decades -- are not able to be discharged.
Instead of selling personal property in order to pay off creditors, the debtor must propose a repayment plan, lasting between three and five years, and this plan must be approved by the court. The debtor must determine an anticipated income throughout the repayment period, and the total amount of debt repaid is based on that anticipated income. The remaining debts that cannot be paid will subsequently be discharged, as determined by the court.