When a person or a company finds themselves in so much financial trouble that they don’t think they’ll be able to handle it, they have the option of declaring bankruptcy. Legally speaking, declaring bankruptcy is the same as declaring that one cannot pay creditors. It gives debtors the chance to settle debts for what they can. The idea is to give those individuals declaring bankruptcy a clean financial slate and the ability to start over.

Chapter 7 & 13

In the United States, there is a set of laws governing bankruptcy known as the Bankruptcy Code. The code is divided into chapters, six of which describe specific types of bankruptcy:

• Chapter 7: basic liquidation for individuals and businesses
• Chapter 9: municipal bankruptcy
• Chapter 11: rehabilitation or reorganization, used primarily by businesses, but can be used by individuals with substantial debts and assets
• Chapter 12: rehabilitation for family farmers and fishermen
• Chapter 13: rehabilitation with a payment plan for individuals with a regular source of income
• Chapter 15: ancillary and other international cases

For individuals, Chapter 7 is the most common type of bankruptcy, followed by Chapter 13.

Choosing a Chapter 7 bankruptcy can be a difficult choice: as part of the proceedings, the debtor gives up their assets. Some assets are exempt, and it’s possible to make arrangements to keep a car or home that the debtor is still paying for. Bankruptcy is not intended to be anything but a last resort, and Chapter 7 can be especially difficult to go through. If a person considering Chapter 7 has much in the way of assets or is involved in a corporation and partnership, filing for bankruptcy under Chapter 11 or 13 may be much better. Chapter 13 offers the opportunity to create a repayment plan: a debtor’s assets aren’t liquidated because they are working to pay off debts rather than have them simply discharged.

The Credit Concern

While bankruptcy may seem like a ‘get out of jail free’ card on the surface, there are some major drawbacks to going through the proceedings. A bankruptcy sticks with a person long after the financial matters have been finalized. Bankruptcies stay on a credit report for ten years. That means that for someone who has been through a bankruptcy will have a much harder time getting credit in the future and more: prospective employers and landlords both look at credit reports and can use a bankruptcy as a reason to refuse to lease an apartment or to offer a job.

Depending on the type of debts at stake, a bankruptcy may not even offer a truly clean slate. It provides a way to eliminate credit card debt and other unsecured credit cards. However, there are a whole list of obligations that bankruptcy does not affect:

• Child support and alimony
• Student loans, except in very limited circumstances
• Most property liens
• Most Tax Debts
• Fines and penalties imposed for legal violations
• Judgments from personal injury suits
• Debts incurred through fraud (lying on a credit application, using borrowed property as collateral, etc.)

Furthermore, any debts not specifically dealt with during bankruptcy proceedings are not discharged. Creditors also have the opportunity to convince the judge during most bankruptcy cases that their debts should survive the bankruptcy.

The first step to filing for bankruptcy — no matter which chapter — is to contact a bankruptcy attorney. All bankruptcies in the U.S. are handled through the United States Bankruptcy Court, but state laws can have some extensive effects on a bankruptcy. It’s crucial to discuss a potential bankruptcy with a local attorney: at the very least an attorney can help explain other options in a particular state. A lawyer will be able to walk a debtor through discovering whether bankruptcy will really discharge enough debt to make it worthwhile. However, not all bankruptcy attorneys are inclined to turn down a potential case unless specifically asked about alternatives.

The Big Benefits

Especially if a debtor takes time to look at all the options available, a bankruptcy can offer some help. Filing Chapter 13, for instance, specifically offers a chance to stop a mortgage foreclosure. And any unsecured debt, like credit card debt, can be very easily dealt with during a Chapter 7 bankruptcy — as long as the debtor is willing to liquidate assets in order to do so.

Beginning bankruptcy proceedings offers another benefit, although it isn’t necessarily monetary: it can stop creditor harassment, as well as collection activities. It may seem like an extreme approach to stop phone calls and letters, but it’s important to remember that collection activities include foreclosures and repossessions. Bankruptcy can provide a short-term solution to stop such situations and hopefully help find a more long-term solution.

Options Beyond Bankruptcy

Surprisingly few people are aware of options beyond bankruptcy for settling their debts. While not all alternatives fit every situation, it is very possible that in a given case, bankruptcy is not the best choice.

• Negotiate with creditors: A debtor can negotiate a repayment plan or settlement plan without going through a bankruptcy court. It’s as simple as picking up the phone and asking. Most creditors know that if a case progresses to bankruptcy, they’re chances of receiving money drop, so they’re usually willing to at least discuss some kind of settlement.
• Debt counseling: A debt counseling agency can help a debtor come up with a repayment plan (similar to Chapter 13) without the black marks a bankruptcy adds to a credit history. There’s a little less legal protection for debtors who miss payments, but for a debtor committed to repayment they can be a better — and cheaper — option than bankruptcy.
• Do nothing: Oddly enough, not acting can be a much better option than bankruptcy in some very specific cases. Creditors can’t take away essentials (basic clothing, household furnishings, personal effects, food) or certain benefits (Social Security, unemployment, public assistance). If a debtor doesn’t have a steady income or property — and doesn’t expect to have them in the future — bankruptcy isn’t necessary. Creditors realize they can’t collect in these situations and rarely try. In seven years, any such debts are removed from a debtor’s credit history.

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