What Is Bankruptcy?
Bankruptcy offers a path to relief from overwhelming debt for people facing financial difficulties. It is a court-supervised process where a person legally declares themselves unable to pay outstanding debts.
There are two types of bankruptcy available to people in debt, often called "consumer debt." You might choose to:
- Determine a debt repayment plan schedule (Chapter 13)
- Discharge most (if not all) debts (Chapter 7)
Small businesses can declare business bankruptcy (Chapter 11). This means the company will close or continue to operate with a reorganization and reduced payments to debtors. Chapter 7 is also available to small businesses that need to close due to significant debt.
Note: For those facing bankruptcy due to COVID-19, you may have special rules applicable to your case.
Chapter 7 vs. Chapter 13 Bankruptcy
Chapter 7 is used to dismiss most debts and give you a fresh start. Some debts are dismissed or repaid because your property is sold to cover the debt. It is the most common chapter to file for.
Chapter 13 bankruptcy involves paying back most of your debt. It is useful for people who want to keep their property but don't have enough income or need more time to make payments.
How To Talk About Bankruptcy
It's essential to understand the terms used in bankruptcy. If you decide to file for it, you will be "declaring bankruptcy." Filing bankruptcy means you are starting the bankruptcy procedure — whether you are approved or not.
Bankruptcy for individuals, married couples, or domestic partners is distinguished by "chapters." Each chapter corresponds to the actual chapter in the U.S. Bankruptcy Code (e.g., "11 U.S. Code Chapter 7"). You must choose which chapter is best for you, file the petition with the courts, and wait to be approved.
After you file your petition, an "automatic stay" goes into effect. This stay stops most collection efforts against you by creditors or collections agencies.
Your case will be assigned a U.S. trustee. They will work with you throughout the process and create a plan for your debt. You can also hire a bankruptcy attorney to help you along the way.
A bankruptcy judge will approve or deny the trustee's plan. You have not officially declared bankruptcy until your bankruptcy claim is approved through a court order.
After the bankruptcy process is complete, the court will remove your liability for certain debts. This is called "debt discharge."
Is Bankruptcy a Good Idea for You?
You should consider many factors before filing for bankruptcy. This includes understanding:
- How your debts, such as credit card debt, are "discharged" or removed
- Which debts you will still need to pay back (nondischargeable debts include student loans, taxes, child support, and alimony)
- Whether bankruptcy will help you keep your home, car, and specific other property protected from creditors' claims or foreclosure (state and federal laws offer what are called bankruptcy exemptions that allow people to keep some property, such as their home through the homestead exemption)
- What impact your declaration of bankruptcy will have on any co-signers
When you declare bankruptcy, it can hurt your credit rating and limit your financial options in the future. But keep in mind that staying in debt can do much more harm to both of these things in the long run. Your credit report will show you declared bankruptcy for the next seven to ten years, though you can get out of debt much earlier than this.
Eliminating Debt in Bankruptcy
Bankruptcy is a great option when you face overwhelming medical bills, credit card debt, and other "unsecured debt" (debt that does not have collateral attached to it). Other common debts that people get rid of in bankruptcy include debt from collection agency accounts, personal loans, past due utility bills, business debts, and past due rent.
You cannot discharge student loans, child support, alimony, most tax debt, debts for willful and malicious injury to another, and debts for injuries caused by DWI/DUI.
To learn more about what debts you can and cannot eliminate in bankruptcy, see our page on Discharging Debt.
A Note on Eliminating Tax Debt
It is vital to know that very few tax debts get discharged. You are still liable for most tax debt after bankruptcy — particularly federal taxes.
However, bankruptcy law allows the discharge of tax debt only in some very limited circumstances. As a rule of thumb, a debtor is more likely to have tax debt discharged in Chapter 7 than in a Chapter 13 bankruptcy.
Should You Hire a Bankruptcy Attorney?
Handling debt and bankruptcy can be confusing and often overwhelming. Doing your research is essential, but sometimes it's in your best interests to consult with an attorney.
An experienced bankruptcy and debt attorney will evaluate your case and explain all your legal options. This should cover everything from the bankruptcy process to more informal debt relief actions (such as negotiating with creditors and lenders and reaching a non-bankruptcy "debt workout" agreement).
For Chapter 7 filings, the average debtor can have their debts discharged within six months. For Chapter 13 filings, the process can take from three to five years. In either case, having an attorney can help you navigate these proceedings.
If you're planning to contact an attorney, use a checklist to gather the documents that the attorney will need to see. This includes financial records, legal records, a combination of assets you own, and your income verification.
United States Bankruptcy Courts 101
Bankruptcy courts are part of the federal judicial system. This means bankruptcy proceedings are governed by federal law. Bankruptcy is handled by specially designated bankruptcy courts in the fifty states, the District of Columbia, and Puerto Rico.
Within larger or more populous states, the bankruptcy courts are divided into districts that serve smaller geographic areas. Each state and district has its own local rules, forms, and opinions that may impact how your case is handled.
If you live in a state with more than one district and are unsure which district you are in, most of the bankruptcy court websites provide lists or maps of counties within that district.
Before you file your bankruptcy petition, make sure you have listed every creditor you owe money. Failure to do so can result in the dismissal of your bankruptcy petition. Lying on a bankruptcy petition can result in a jail sentence for fraud.
Bankruptcy Forms and Resources
Whether you're seeking information about credit counseling services or plan to file for bankruptcy protection, you'll need to become acquainted with various legal forms, filing procedures, and government offices.
Without the proper guidance, navigating these forms and procedures can make filing for bankruptcy a pretty overwhelming experience. You'll want to:
- Find your state's bankruptcy court directory
- Learn how to draft a "cease communications" letter to creditors
- Gather the correct documents
- Review U.S. bankruptcy laws to prepare yourself
- Get help from a credit counselor to develop a personalized plan for getting back on track
It is a good idea to work with a bankruptcy attorney who knows the ins and outs of the bankruptcy process. You may also want to learn about common definitions and explanations for frequently-used words and phrases related to bankruptcy.
Bankruptcy Code - U.S. Code Title 11
The laws we follow for bankruptcy are parts of the United States Code. Title 11 covers all elements of federal bankruptcy law and what each chapter does.
There are general elements that cross all bankruptcy cases and chapter-specific rules that you, your trustee, and creditors must follow.
2005 Bankruptcy Law Changes
The Bankruptcy Reform Act was passed in 2001. Soon after, bankruptcy law was reconsidered in 2005. This set of rules is officially called The Bankruptcy Abuse Prevention and Consumer Protection Act of 2005.
At the time, it was a major reform of the bankruptcy system, including tighter eligibility requirements, such as:
- Chapter 7 applicants must meet specific eligibility requirements under a "means test"
- Chapter 7 or Chapter 13 applicants must show proof of their income by providing federal tax returns from the last tax year
- Most applicants must undergo credit counseling in a government-approved program before filing for any chapter
- Before any debt is discharged, bankruptcy debtors must participate in a government-approved financial management education program
Another change included removing some of the protections that happen with the "automatic stay." One key difference is that filing for bankruptcy no longer delays or stops eviction actions.
How a Bankruptcy Attorney Can Help
Bankruptcies occur because of bad decisions or unexpected circumstances. Professional assistance can help prevent missteps and misunderstandings from compounding your problems.
Contact an experienced bankruptcy attorney to discuss how they can help ensure that your bankruptcy results in a fresh start and not a new round of problems.
- Bankruptcy Definition: What Exactly Is It?
- Benefits of Bankruptcy
- When Should I File for Bankruptcy?
- What Happens When You File for Bankruptcy?
- What is a Trustee in Bankruptcy?
- Bankruptcy Courts
- Bankruptcy and Discrimination
- Bankruptcy and Members of the Military
- Can You File for Bankruptcy While Unemployed?
- Ask a Lawyer: Can Bankruptcy Affect Your Job Prospects?
- Will Filing For Bankruptcy Cause an IRS Audit?
- Is Bankruptcy a Good Idea?
- Bankruptcy: Advantages and Disadvantages
- Bankruptcy and Foreclosures
- Finding a Bankruptcy Alternative
- Can You Clear Medical Debt in Bankruptcy?
- Ask a Lawyer: Can Bankruptcy Clear Lawsuit Judgments?
- Ask a Lawyer: Can Bankruptcy Stop Wage Garnishment?
- Bankruptcy and Taxes: Eliminating Tax Debts in Bankruptcy
- Can Filing for Bankruptcy Clear Credit Card Debt?