Bankruptcy is a legal declaration of an individual or company’s inability to repay creditors. The context of bankruptcy changes significantly depending on whether it involves a person or a company, and there are various forms of this financial protection. While it is a form of financial protection in one sense, it is without exception always an undesirable outcome for all parties concerned and is usually only used as a last resort. In some cases involving businesses, creditors can file involuntary bankruptcy against businesses that owe them money, in hopes of being paid before any other creditors the business may have.
We usually think of bankruptcy in the context of individuals however, and involuntary bankruptcy cannot be imposed on people. The concept of bankruptcy is more defined in capitalist economies and exists as a necessary evil designed to give people a second chance in extreme cases. In the United States, a bankruptcy provision was actually included in the Constitution when it was adopted in 1789. While the original proviso did not include personal bankruptcies and was limited to businesses, the laws governing bankruptcy have evolved over time and have been modified as recently as 2005 with the Bankruptcy Abuse Prevention and Consumer Protection Act.
There are six different types of bankruptcy, with the most common form being Chapter 7. This is the simplest form of bankruptcy for people and businesses alike. Essentially, Chapter 7 involves a liquidation of as many assets of possible in order to generate enough cash to repay as much debt as possible. For most business bankruptcies, almost all assets can be sold, but for individuals it’s not quite that simple. It is extremely rare for a person who declares bankruptcy to escape without having to pay back at least some portion of what they owe, and it is never a simple, cut-and-dry procedure.
Bankruptcy is a legal procedure governed by a court, with all parties being represented by lawyers that seek what is best for their client. The assets of the person declaring bankruptcy are carefully reviewed to determine which can be taken and which are protected. Once the assets are identified and sold, they are applied to the debts outstanding based on the order in which different creditors have claim, which can be quite complicated to determine. It is interesting to note that not all debts can be forgiven with bankruptcy. Student loans, child support, and taxes can’t be discharged because they represent an obligation to the government and/or, to some degree, society.
Additionally, certain behaviors can limit a person’s right to declare bankruptcy. If theft, fraud, or other falsification of financial records has been engaged in, bankruptcy may not be an option, and certain personal assets that would otherwise be protected from liquidation may be forfeited, which is often the case when a person ends up going to prison.
Declaring bankruptcy is never the easy solution it is advertised to be by lawyers who specialize in representing individuals in bankruptcy proceedings, and should only be done after careful consideration of the other available options for repayment, settlement, or credit repair.