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

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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 likely hood of having financial improvements during the break.

Bankruptcy – Useful Info at a Glance

  • What is bankruptcy? Bankruptcy is a legal process through which individuals or businesses who are unable to repay debts to creditors seek relief.
  • What kinds of bankruptcy are there? For individuals, Chapter 7 and Chapter 13. For business, Chapter 11.
  • 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.

What is Bankruptcy?

Bankruptcy is used in the legal framework to define a process where a business not capable of repaying its debts takes a reprieve from its creditors. Bear in mind that some of the debts not covered by filing for bankruptcy are student loans, recent taxes, and child support. 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 gives business owners an opportunity 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.

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, it is critical that you understand how different bankruptcy laws change with every situation.

The most common bankruptcy codes in the United States for business owners are chapter 7 (Liquidation) and Chapter 11 (Reorganization). We will cover these two in detail.

Chapter 7 or 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; the help of an attorney is always advisable.

Chapter 11 or Reorganization Bankruptcy

Business owners who run into trouble can seek refuge by using chapter 11 to reorganize their finances. Chapter 11 is best for business with a keen interest in continuing their operations; it doesn’t require the cease in 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 get access to 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.


Choosing the right type of bankruptcy depends majorly on two things: the 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, and when your repayments stagnate your progress and you are unable to meet other financial obligations. You can learn here all the possible scenarios where filing bankruptcy may be the most reasonable option. 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.

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