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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More than a few companies are having some financial trouble these days, and some are even starting bankruptcy proceedings. If a company that you do business with is in that category, you may need to take a few extra steps to guarantee that there isn’t a ripple effect into your finances.

1. Check if the business will continue to honor returns, exchanges and gift cards and other customer programs. If a company has gone into bankruptcy proceedings, it needs permission from the court to continue such programs. In general, the court will typically approve such requests but it can depend on the specifics of the situation. Furthermore, during bankruptcy proceedings, customers aren’t always a priority — creditors usually take precedence.
2. Wind up any existing business as soon as possible. If you’ve been sitting on a credit, it’s generally advisable to spend that early. Otherwise you may wind up in a position where you’re hoping a store will honor its obligations but you don’t have a guarantee.
3. Use a credit card for any new purchases. If a company can’t deliver on merchandise, you can dispute the charge with your credit card company. You also generally have a little more latitude when it comes to returns. Cash, check and debit cards have none of the consumer protection offered by a credit card. You may also want to limit new purchases from a company in bankruptcy. You definitely want to avoid purchasing such a company’s gift cards or warranties.
4. Verify your warranties. Check into whether your warranties for products bought through the bankrupt business are actually from the business or from a third-party warranty issuer. No matter which, check to make sure that the warranty is still in effect. Don’t be surprised if it isn’t, though: it’s not uncommon for warranties to be ignored if a business runs into trouble.
5. Find another supplier. Even if the company can find a way to reorganize and stay in business, there are likely to be delays in fulfilling orders and conducting other business. It’s unfortunate but if you need to guarantee that you get your products, you should start hunting for a new supplier now.
6. File a claim with the bankruptcy court. If the business in question can’t make good what it owes you, you may have no other recourse than to file a Proof of Claim form with the court overseeing the bankruptcy proceedings. Unfortunately, if a company is in a poor enough position to declare bankruptcy in the first place, it may take years to resolve — and other creditors may be ahead of you to get paid.

If you aren’t sure if a company that you do business with has actually entered bankruptcy proceedings, you can usually find out by searching the American Bankruptcy Institute’s website. The ABI reports on bankruptcy news on a regular basis. If you’re dealing with a small, local company, however, you may find more information by contacting your local Better Business Bureau or a local consumer protection agency. Even if such organizations don’t have specifics on bankruptcies, they can at least inform you of problems other shoppers are having.

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