Bankruptcy is a legal process that allows consumers and business entities to eliminate some, or all, of their debts by order of a federal court. While bankruptcy gives individuals and businesses a fresh start, as the court forgives debts that cannot be paid, it also gives creditors an opportunity to get at least partial repayment, based on what assets the individual or business has available. To explore this concept, consider the following bankruptcy definition.

Definition of Bankruptcy


  1. A state of utter ruin, failure, or depletion
  2. The state of being bankrupt


1690-1700        English bankrupt + -cy

What is Bankruptcy

Bankruptcy can be a powerful tool for an individual or business facing severe financial distress. There are several types of bankruptcy in the U.S., each referred to as a “chapter,” and described and governed by Title 11 of the United States Code. In certain circumstances, an individual’s debts may be completely wiped out in bankruptcy, while in others, an individual’s or business’ debts are restructured, to be paid on a very specific payment plan. In either case, once bankruptcy has been filed, the collection process stops, providing a great deal of stress relief.

History of Bankruptcy

The history of bankruptcy in the U.S. dates back to the 1700s, having been adopted from English common law. Originally, bankruptcy was viewed as a quasi-criminal act. In 1789, Congress was given power to legislate bankruptcy laws according to the Constitution. Congress eventually adapted bankruptcy law to helping individuals and businesses suffering severe economic losses to solve the problem and repay their debts.

When the Bankruptcy Act of 1800 was enacted, it was limited to initiating involuntary bankruptcy proceedings against traders. It was repealed three years later, and U.S. bankruptcy law gradually adopted the concept of voluntary bankruptcy. The Bankruptcy law of 1898, also known as “the Nelson Act,” finally established a workable relationship between creditors and debtors.

In 1938, the Chandler Act expanded the concept of voluntary bankruptcy, giving authority over bankruptcy to the Securities and Exchange Commission. In 1978, the Bankruptcy Reform Act of 1978, now referred to as the Bankruptcy Code, overhauled the system. This act established the structure of U.S. bankruptcy courts, and gave judges discretion when it comes to deciding bankruptcy cases.

Types of Bankruptcy

The U.S. Bankruptcy Code specifies five different bankruptcy types: chapter 7, chapter 13, chapter 11, chapter 9, and chapter 12. Each type is intended for specific circumstances, depending on whether the bankruptcy is filed by a person or a business, and the value of their assets, earning capacity, and the debt-to-income burden.

Chapter 7 Bankruptcy

Chapter 7 bankruptcy is available to individuals and married couples. Also referred to as a “straight bankruptcy,” Chapter 7 allows the debtor (the person or entity that files bankruptcy) to keep his household and personal items, such as furnishings and clothing, and usually his home and car, as long as they do not exceed a certain value. If the debtor owes money on the home or car, he can keep them only if he works out a deal with the loan and mortgage companies to continue making payments until they are paid off.

Not all people are eligible for Chapter 7 bankruptcy, which has certain income and net worth requirements. Chapter 7 bankruptcy takes about 6 months to complete. At the end of the case, the bankruptcy judge issues a Discharge Order, which can be used to prove the debtor’s debts have been wiped out.

Chapter 13 Bankruptcy

Chapter 13 bankruptcy is a form of bankruptcy that may be filed by individuals and married couples, and involves the creation of a debt repayment plan. In Chapter 13, unsecured creditors, meaning those who have extended credit without requiring any property or assets as security, generally only receive a small percentage of the amount owed by the debtor.

The debtor must, however, pay past due taxes in full, and keep them current, and he must pay the full amount past due on any secured debt, such as a car loan or home mortgage. At the end of a Chapter 13 bankruptcy, most of the debtor’s debts are wiped out by a discharge, some creditors having received partial payment, others receiving none.

To be eligible for Chapter 13 bankruptcy, the debtor must have a reliable source of income, as he will be required to repay at least some of the debt he has accrued. Additionally, the federal government sets the amount of debt allowed under Chapter 13 bankruptcy. As of 2015, a person cannot have more than $1,149,525 in secured debt and $383,175 in unsecured debt.

Chapter 11 Bankruptcy

Chapter 11 bankruptcy is generally reserved for large corporations with heavy debt burdens, though it can be used by small businesses also. Chapter 11 bankruptcy, also referred to as “business reorganization,” provides a way for businesses to pay off, or pay down, their debts over time, without losing their possessions. Chapter 11 bankruptcy is more costly for the debtor, and takes quite a bit more time to complete than Chapters 7 and 13.

Chapter 12 Bankruptcy

Chapter 12 bankruptcy is similar to Chapter 13 in structure, but provides additional advantages for family farmers and family fishermen, meaning those whose families engage in farming or fishing as a business. These small family farmers and fishermen are the only ones eligible for Chapter 12. Chapter 12 bankruptcy has a very limited scope, and so anyone considering filing this type of bankruptcy must meet certain strict income and conduct requirements.

Chapter 9 Bankruptcy

Chapter 9 bankruptcy is available only to municipalities, meaning the governing bodies of cities, towns, and districts with a corporate existence. Chapter 9 bankruptcy is another form of reorganization bankruptcy, though because a municipality is an entity of a state government, the bankruptcy court is limited in what it can order.

Municipalities that have filed Chapter 9 bankruptcy:

The collapse in real estate values in 2008 put the city of Stockton, California in a serious financial crisis. On June 28, 2012, Stockton became the largest city in U.S. history to file for Chapter 9 bankruptcy protection. While the Stockton bankruptcy case gained nationwide attention and lasted more than two years, its scope was surpassed by the city of Detroit, Michigan, only one year later.

What Bankruptcy Cannot Do

Bankruptcy can be a lifesaver for someone struggling with an overwhelming amount of debt. There are, however, limitations as to what bankruptcy can do. A few of the things bankruptcy cannot do for a person include:

  • Prevent Repossession of Secured Property – Bankruptcy typically does not eliminate liens, and if a debtor has a secured debt, the creditor can legally repossess the property regardless of whether bankruptcy has been filed.
  • Eliminate Child Support Obligations – Child support obligations are not eliminated when a person files bankruptcy. The same is true of alimony. If a court has ordered either of these, the debtor remains responsible for paying them in full, regardless of his bankruptcy status. If filing Chapter 13 bankruptcy, the debtor must include child support and alimony payments in his q repayment plan.
  • Eliminate Student Loans – It is very rare for bankruptcy to eliminate student loans. In fact, the only time this might occur is when the debtor can prove that repaying the loans would cause him an undue hardship. This requires very strict criteria to be met.
  • Eliminate Tax debts – Delinquent taxes are rarely discharged in bankruptcy, though it is possible in some circumstances. If the debtor has older, unpaid income taxes, and meets certain specific requirements, such a debt might be discharged.

Elimination of Non-dischargeable Debts

There are a number of non-dischargeable debts not listed above, that cannot be eliminated by bankruptcy. These include:

  • Debts not listed in the bankruptcy papers (with certain exceptions in Chapter 7)
  • Debts for damages awarded in a personal injury or wrongful death cases caused by the debtor’s driving while intoxicated
  • Fines for criminal convictions
  • Debts that a creditor proves should survive bankruptcy

Involuntary Bankruptcy

Involuntary bankruptcy is filed by a creditor against a business in an attempt to recover some of their money. This is more common when a creditor knows that the business can pay, but refuses to do so. While involuntary bankruptcy against an individual is permitted, it is rare, as creditors do not typically recoup their losses.

Involuntary bankruptcy is initiated when one or more creditors files a petition with the bankruptcy court. The debtor then has 20 days to respond and if they fail to do so, the court grants the bankruptcy. When this occurs, the debtor is forced to participate. In most jurisdictions, at least three creditors must join the petition, and the amount of combined unsecured debt must be at least $14,425.

Filing Bankruptcy

The first step in filing bankruptcy is finding an experienced attorney. An attorney is not required, but the bankruptcy process is complex, and using an attorney helps ensure it is done correctly. The attorney will help the debtor complete the necessary forms, including the petition, schedules, and creditor lists and notifications. All of the forms must be filled out completely and honestly. An individual considering filing bankruptcy on his own, or who would like to review the requisite forms, may find bankruptcy forms as the federal bankruptcy website:

Once the necessary forms have been filed, the debtor must gather together supporting documentation, and modern bankruptcy laws require each debtor to obtain official credit counseling, and provide proof of completion. The court assigns a bankruptcy trustee to each case. This is the person who will review all of the documents, investigate the debtor’s financial circumstances, and determine whether any debtors are objecting to the bankruptcy. In many cases, the bankruptcy is approved at this stage, by the trustee, with the debtor never appearing at court. In complex cases, however, such as those involving large corporations, large debt burdens, and other special circumstances, at least one hearing will be held.

Bankruptcy Court

Every state in the U.S. has a bankruptcy court within its judicial district. Every state has at least one district, with larger states having more. Judges presiding over bankruptcy hearings have the authority to make judicial decisions, though much of the proceedings take place outside of the courtroom, under the direction of a bankruptcy trustee. It is common for bankruptcy applicants to never set foot in court unless there are objections by creditors to their proposed plan.

Bankruptcy Attorney

Since bankruptcy is a complicated process, and certain specific forms need to be completed properly, most individuals and businesses seeking to file bankruptcy turn to experienced bankruptcy attorneys to help them with the process. Some bankruptcy attorneys even specialize in the more complex types of bankruptcy, such as chapters 12 and 9. It is recommended by many legal professionals that the bankruptcy attorney hired have experience with situations similar to the debtor’s issues.

Related Legal Terms and Issues

  • Creditor – A person or entity to whom money is owed by another person or entity.
  • Debtor – A person who is in debt, or under a financial obligation to another.
  • Hearing – A proceeding before the court at which an issue of fact or law is heard, evidence presented, and a decision made.
  • Judicial Decision – A decision made by a judge regarding the matter or case at hand.
  • Jurisdiction – The legal authority to hear legal cases and make judgments; the geographical region of authority to enforce justice.
  • Unsecured Debt – A debt for which no property serves as collateral of, or guarantee for, repayment.

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