When an individual or business is unable to make payment to creditors to pay off their debts, they can file for bankruptcy protection under the bankruptcy laws of the United States.
For an individual, bankruptcy protection may involve either a cancellation of most debts, along with the selling off of some of their assets, or a structured plan to pay down the debts that are owed.
For a business, bankruptcy protection may either provide complete or partial relief of debts and contracts, assuming the business will remain in operation, or the business may cease operation and sell off its assets to pay debts.
There are two types of bankruptcy protection commonly used by individuals: Chapter Seven, and Chapter 13, where “chapter” refers to the chapter of the bankruptcy code that describes each one. In Chapter Seven, also called a “straight bankruptcy” or “liquidation”, a trustee is appointed to control the individual’s assets. The trustee then liquidates, or sells the assets, then gives the money to creditors in order to pay off debts, to the extent that this is possible. However, the individual is allowed to keep some personal property, depending on the laws of the state in which they live.
Chapter 13, also called wage-earner bankruptcy, allows the individual to propose a plan to repay their debts interest-free over a three to five-year period, although the individual’s payment plan is subject to court approval. While in Chapter 13, an individual is protected from creditors collecting on debt or seizing assets to pay debts. Creditors are required to abide by the terms of the approved payment plan. Both types of personal bankruptcy make it very difficult for the individual to obtain credit for a period of seven to ten years after seeking bankruptcy protection.
Businesses may also seek bankruptcy protection under Chapter Seven, but also under Chapter 11, which consists of a reorganization, rather than a liquidation of assets. It may take anywhere from months or years for a business to emerge from this type of bankruptcy.
As in Chapter 13, a business in Chapter 11 may propose a repayment plan for its debts within a certain time frame, after which it is up to the creditors to come up with a plan. If the business has stock that is traded on a public stock exchange, then the stock is no longer allowed to be traded publicly once bankruptcy protection is pursued. In some cases, this causes the value of the company’s stock to go to zero.
For businesses, and especially for individuals considering bankruptcy, it is highly advisable to retain the counsel of a bankruptcy attorney, due to the complexity of bankruptcy laws, which also vary slightly from state to state.