What Is Bankruptcy?

Bankruptcy is a legal process designed to help individuals and companies get a financial fresh start by discarding or making arrangements to repay unmanageable debt. It can also be a way for companies to end business and liquidate assets in an orderly way.

The Purpose of Filing Bankruptcy

The desired outcome of most bankruptcy cases filed by individuals is a discharge. A discharge is an order from the bankruptcy court permanently prohibiting any creditor from attempting to collect the discharged debt from the debtor. It's also known as a bankruptcy injunction.

Although the discharge is permanent, it is not all-inclusive. Some debts are not dischargeable. For example, most tax debts, child support, and spousal support cannot be discharged.

As the bankruptcy discharge is a very powerful remedy, it is only given to honest debtors that disclose all of their property and debts.

The Bankruptcy System

The bankruptcy system is operated by the U.S. Bankruptcy Courts as outlined in the U.S. Bankruptcy Code.

The bankruptcy courts are subunits of the federal district court system. As a result, there is a bankruptcy court in each federal district of the United States. However, depending upon the population of a district, there may be multiple courthouses in different cities. Bankruptcy courts are supervised by bankruptcy judges that are appointed to 14-year terms by federal judicial committees.

Types of Bankruptcy

There are six type of bankruptcy, known as chapters:

  • Chapter 7 liquidation is by far the most common bankruptcy chapter for individuals. It calls for the sale of a debtor's nonexempt property. The proceeds are then distributed to their creditors. Chapter 7 liquidation is appropriate for individuals who do not have a regular income and cannot or do not wish to use Chapter 13's payment plan system.
  • Chapter 13 bankruptcy is the second most common chapter for individuals. It permits a debtor who is making a regular income to repay at least a portion of debt over a period of three to five years. 
  • Chapter 11 is used by businesses to reorganize complex debt structures. 
  • Chapter 9 is used by municipalities and other political subdivisions like utility, hospital, airport, or school districts.
  • Chapter 12 is for family farmers and fisherman.
  • Chapter 15 is filed by foreign debtors who usually are companies with bankruptcy or receivership actions pending in other countries. 

Bankruptcy can have long-term financial and legal consequences. If you're thinking about filing for bankruptcy, then it's wise to consult a lawyer who specializes in this area. If you can't afford a lawyer then check with the American Bar Association to find out if you qualify for free legal help.

Bankruptcy Trustees

In the vast majority of bankruptcy cases, a trustee is automatically appointed when the case is filed. The trustee administers the bankruptcy case by reviewing the documentation of the debtor.

In a Chapter 7 case, the trustee will attempt to sell any non-exempt property to pay creditors. The trustee also has the obligation to be vigilant for fraudulent conduct and failure of the debtor to disclose information. They owe a fiduciary duty to the creditors and must collect as many assets as possible to pay creditors.

Bankruptcy Fraud

As bankruptcy is a federal system codified by Congress into the United States Bankruptcy Code, bankruptcy fraud falls under the domain of the federal government. Specifically, bankruptcy fraud, which includes false oaths, failure to disclose debts or assets, and other fraudulent conduct, is a federal crime. Committing bankruptcy fraud can lead to you losing your discharge and could very well land you in jail.

Although the federal government keeps a watchful eye out for bankruptcy fraud, any creditor of a bankruptcy debtor can file a complaint against the debtor. The complaint may seek to deny the debtor a discharge for bankruptcy fraud. In addition, the complaint may seek a judgment by the bankruptcy court that the debt owed to the creditor is non-dischargeable in bankruptcy. A debt may be non-dischargeable under the bankruptcy laws or because the credit was obtained by fraudulent means. Bankruptcy is certainly not a safe haven for the unscrupulous debtor.