What Is Bankruptcy?
Bankruptcy is a federal legal process that provides a structured path for individuals and businesses to address debt they cannot repay. It can apply to everyday individuals, businesses of all sizes, local governments, farms, and fisheries. For some, it is a path to total debt discharge. For others, it is a tool to restructure obligations under court protection while continuing to operate.
Bankruptcy is not a solution for everyday debt or a single missed payment. It is a last resort for situations involving extreme debt, lawsuits from creditors, wage garnishments, pending evictions, or imminent foreclosure. It is strongly recommended that licensed attorneys be involved throughout the process.
The Automatic Stay
Upon filing a bankruptcy petition, an automatic stay goes into effect immediately. It legally forces all creditors to halt collection actions while the case proceeds. This provides the debtor immediate breathing room to organize and respond.
- Foreclosures halted
- Repossessions stopped
- Wage garnishments paused
- Eviction proceedings frozen
- Creditor calls must cease
- Lawsuits suspended
The Three Main Types of Bankruptcy
The most common bankruptcy filings are named for their chapters in the US Bankruptcy Code. Each serves a different purpose and is appropriate for different situations:
Liquidation Bankruptcy
Individuals & BusinessesThe most common bankruptcy for individuals. A court-appointed trustee collects and sells non-exempt assets, distributes proceeds to creditors, and — for qualifying individuals — discharges any remaining debt. Businesses use Chapter 7 when there is no viable path to reorganization and the goal is orderly wind-down.
To qualify, individuals must pass an income means test — demonstrating that their monthly income falls below their state’s median. There is no minimum or maximum debt level required. The entire process typically completes in 3–6 months.
Key distinction: Filers cannot dismiss a Chapter 7 case once filed. If an individual earns too much to qualify, they may instead file under Chapter 13.
Reorganization Bankruptcy
Primarily BusinessesThe standard bankruptcy option for businesses facing temporary financial distress but with a viable path to profitability. The company continues operating while working through the court process. A trustee is typically not appointed — the debtor manages its own business as a “debtor in possession.”
The business develops a reorganization plan outlining how its debts will be repaid over time — usually without liquidating assets. The goal is to emerge as a leaner, restructured operation rather than to close. Upon plan confirmation, the debtor receives a discharge of pre-confirmation debt, with some exceptions.
Individuals and partnerships may also file Chapter 11, though it is less common for individuals.
Repayment Plan Bankruptcy
Individuals OnlyDesigned for individuals (including self-employed) who have regular income but need structured time to repay debts. Partnerships and corporations cannot file under Chapter 13. The debtor proposes a 3–5 year repayment plan covering all disposable income. A trustee oversees payments to creditors. At plan completion, the debtor receives a discharge of remaining eligible debt.
Chapter 13 is often used by people who earn too much for Chapter 7, own a home they want to keep, or have other assets they wish to protect. Unlike Chapter 7, only the debtor — not creditors — can initiate Chapter 13, and the debtor may dismiss the case.
Quick Comparison
| Feature | Chapter 7 | Chapter 11 | Chapter 13 |
|---|---|---|---|
| Who can file | Individuals & businesses | Individuals & businesses | Individuals only |
| Approach | Liquidation | Reorganization | Repayment plan |
| Business continues operating | No | Yes | If self-employed |
| Income test required | Yes | No | Regular income required |
| Timeline | 3–6 months | Months to years | 3–5 years |
| Assets liquidated | Yes (non-exempt) | Typically no | No |
| Debtor can dismiss | No | No | Yes |
Consequences of Bankruptcy
Credit Score Damage
A bankruptcy filing can lower an individual’s credit score by as much as 200 points. The bankruptcy remains on credit reports for 7 years (Chapter 13) or 10 years (Chapter 7), affecting access to credit, rental housing, and sometimes employment.
Not All Debt Is Erased
Certain debts survive bankruptcy and cannot be discharged. The debtor remains fully liable for these obligations regardless of bankruptcy outcome.
Foreclosure Risk Remains
After Chapter 7 or 13 proceedings conclude, debtors may still face foreclosure on their home if mortgage payments are not current. Bankruptcy can delay but not necessarily prevent foreclosure.
Stock Investments Wiped Out
In corporate bankruptcies, common stockholders suffer last. All other creditors are prioritized ahead of equity holders. If you own stock in a company that files Chapter 11, that investment is typically reduced to zero.
Debts that cannot be discharged include:
- Alimony & child support
- Student loans (in most cases)
- Most federal tax obligations
- Criminal fines & restitution
- Debts from fraud or willful misconduct
- Some tax-related debts
Before Filing: Consider the Alternatives
Bankruptcy is a significant legal action with long-lasting consequences. Before filing, it is worth exploring whether debt restructuring, negotiation, or consolidation strategies could resolve the situation with less impact on your credit and financial future.
The decision to file should be made with the guidance of a licensed bankruptcy attorney, who can evaluate your specific circumstances, identify which chapter is appropriate, and navigate the complex paperwork requirements.
We offer debt reduction strategies done the right way. If you are exploring options before reaching bankruptcy, or if you want to understand how debt management fits into your broader financial picture, contact us for a free, no-obligation consultation.