Gavel and dollar banknotes. Concept: What is bankruptcy?
James Njau
By: jnjau
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What is Bankruptcy? The Most Common Types of Bankruptcy

The term “bankruptcy” is associated with extreme and negative situations that may force you to wind your operations. But when your business fails and your debt is out of control, filing for bankruptcy can partially ease the situation and get the debt collectors off your back. The overall process may be tedious, but there is a likelihood of having financial improvements during the break.

In this article, you’ll find all the information you need about what bankruptcy is, what types there are, when to file bankruptcy, how to rebuild your credit after one, and more.

Close-up of a bankruptcy petition

What is Bankruptcy?

Bankruptcy is a legal process through which individuals or businesses who cannot repay debts to creditors seek relief.

It is used in the legal framework to define a process where a business cannot repay its debts takes a reprieve from its creditors.

All cases of bankruptcy are handled by the federals courts. The decision to pay or not to repay lies in the hands of a bankruptcy judge. The evidence is what guides the judge to reach the final decision.

When a debtor declares his or her state of bankruptcy, the hearing commences. Two outcomes are likely; discharge or the restructuring of debt. In rare cases, a trustee can be appointed to run your business to implement the pending payments.

Bankruptcy allows business owners to get out of debt while working with traders in a fair manner. Once the entire ordeal ends, most debtors will feel much better to start afresh.

Some of the debts not covered by filing for bankruptcy are student loans, recent taxes, and child support.

What is an Exception?

An exception in the world of bankruptcy refers to the properties and assets that can be retained as you let go of other items. Schedule C talks about personal property as an exception and belongs to the owner even when in debt. Exceptions are only accessible to a debtor filing for bankruptcy.

Most Common Types of Bankruptcy

The bankruptcy code defines six types of bankruptcy levels. For the purpose of this article, we will cover only those that are more common among business owners.

Once you file for bankruptcy, you need to know that your credit score will receive a negative impact. A bankruptcy can stay in your credit history for up to ten years.

Therefore, you must understand how different bankruptcy laws change in every situation.

The most common bankruptcy codes in the United States for business owners are chapter 7 (Liquidation), Chapter 11 (Reorganization), Chapter 13 (Adjustment of Debts), and Chapter 12 (For Farmers & Fishermen).

We will cover these four in detail.

Chapter 7, bankruptcy

Chapter 7: Liquidation Bankruptcy

Liquidation bankruptcy is most suitable for individuals, but it’s also available for businesses.

Liquidation is the simplest form of bankruptcy, and that’s why it’s also called “straight bankruptcy.” Chapter 7 is also the most common form of bankruptcy.

Chapter 7 liquidation bankruptcy is suitable for consumers with unsecured debts that can be forgiven. You can file for this code when you have unpaid loans, credit card debt, medical bills, or personal loans.

These are some of the requirements to file for Chapter 7:

  • You must have a positive result on the means test that determines your qualification status with regard to chapter 7.
  • You must have a clean record in the last eight years or have a chapter 13 discharge in the previous six years. You may not be eligible if, in the last 180 days, you filed a bankruptcy petition and failed to comply with court orders or you dismissed your application when creditors presented their cases to recover the property.

Have in mind that the following types of debt are not dischargeable through Chapter 7:

  • Tax Debts
  • Student loans
  • Child or spouse support

Chapter 7 filings involve many forms and navigation of legal issues; an attorney’s help is always advisable.

Chapter 11, bankruptcy

Chapter 11: Reorganization Bankruptcy

Business owners who run into trouble can seek refuge by using chapter 11 to reorganize their finances. Chapter 11 is best for businesses with a keen interest in continuing their operations; it doesn’t require the cease of operations, and businesses can rewrite bargaining agreements and restructure some of the terms in every financial obligation.

In other words, filing for this chapter involves corporate financial restructuring that allows companies to function as they pursue debt repayment through chapter 7.

A trustee appointed by the court can run your business to make it easier for you to access funds. New lenders get their dues before everyone else.

The moment you file for chapter 11, you and your business will get an automatic status that protects you against litigations until your business regains its feet. All litigations either can be part of the bankruptcy file or forwarded to the day the business re-emerges from its current state.

Chapter 13, bankruptcy

Chapter 13: Adjustment of Debts Bankruptcy

This type of bankruptcy is most suitable for individuals. If you have a Sole Proprietorship, this might be the bankruptcy you need. This type of bankruptcy allows you to stay in business while you repay your debts; it will also help you protect your personal property and assets (like your house).

To file this type of bankruptcy, you will need to prove that you have a steady income that will allow you to pay your debts (the court will plan with you a repayment plan, usually 3 to 5 years).

Have in mind that the following types of debt are not dischargeable through Chapter 13:

  • Alimony
  • Child support
  • School loans
  • Mortgages

Chapter 12, bankruptcy

Chapter 12: Bankruptcy for Farmers & Fishermen

This type of bankruptcy is very similar to chapter 13. The only difference is that it is only available for family farms and family fisherman. It allows them to stay in business. 

If you file for this type of bankruptcy, you need to come up with a repayment plan 90 days after you file; the repayment plan usually lasts 3 to 5 years.

bankruptcy guide, infographic. camino financial


When should you file for bankruptcy?

Choosing the right type of bankruptcy depends majorly on two things: your income and the assets you own. The reasons why individuals and businesses file for bankruptcy are to shield themselves from aggressive creditors and enable them to build enough money for repayment.

Filing for bankruptcy is not an easy thing to do, but you still have to weigh on the difficulties of the whole process.

Bankruptcy filing seems to make sense in the following situations:

  • when there is no likelihood of you making repayments within five years
  • when you have a debt that is more than half of what you earn
  • when your repayments stagnate your progress, and you are unable to meet other financial obligations.

Before you consider filing for bankruptcy, seek other alternatives and strategies to pay off debt or find out if your amount of debt is too risky by learning about the debt service coverage ratio.

Learn about all the possible scenarios where filing bankruptcy is the most reasonable option:

Bankruptcy FAQs – Useful Info at a Glance

What kinds of bankruptcy are there?

For individuals, Chapter 7 and Chapter 13. For business, Chapter 11.

What happens if I declare bankruptcy?

When you file for bankruptcy, your debtors cannot collect what you owe them. Some of these debts will be eliminated, some others you will have to pay over time. The specifics of what happens when you file for bankruptcy depending on the type of bankruptcy and your specific situation.

The government will also ask you to take credit counseling and a debt education course.

Is filing for bankruptcy bad?

Yes and no. It is bad because it will affect your business and severely hurt your credit score (with Chapter 7, it will appear on your record for 10 years). But it is a good thing because it can help you solve all your debt problems.

What is the most common type of bankruptcy?

The most common type of bankruptcy is Chapter 7 or liquidation bankruptcy. Chapter 7 is most suitable for individuals, but it’s also available for businesses. Liquidation is the simplest form of bankruptcy.

What is the difference between Chapter 7, 11, and 13 bankruptcy?

  • Chapter 7 bankruptcy forgives the debtor of most of their debt. Chapter 7 is a discharge or liquidation of debts, which is the traditional bankruptcy.
  • Chapter 13 bankruptcy requires that the debtor comes up with a plan to repay their creditors within a three to five-year period. After this period, the debt is forgiven.
  • Chapter 11 bankruptcy is generally for small business owners. Chapter 11 allows business owners to retain their business while paying back their debts according to a structured plan.

Do you get out of all debts if you declare bankruptcy?

Bankruptcy doesn’t relieve you of all your debts. You will not need to pay for most unsecured debts. If you have any secured debts, you will have to give the purchased item back. Filing for bankruptcy will not get you out of student loans, recent taxes, and child support.

Rebuilding Your Credit After a Bankruptcy

First of all, you must know that bankruptcy is not the end. While it may seem that you can’t continue in business after a bankruptcy, you should know that you can recover. And you will!

You should also know that your credit score will take a big hit if you ever file for bankruptcy. Fortunately, there’s a fix for that.

While the process can take a while, it’s definitely worth it.

Some of the things you can do are:

  • Checking your credit report for inconsistencies
  • Making sure you pay every single bill on time
  • Asking for payments to be reported to a credit bureau

These are just a few things you can do, but you can learn even more in this article:

Closeup on notebook over wood table background, focus on wooden blocks with letters making Bankruptcy word. Business concept image. Laptop, glasses, pen and mobile phone in a defocused background. Concept: rebuild credit

How to Rebuild Credit After a Bankruptcy

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