What Is Bankruptcy?

Bankruptcy is a financial safety net established by federal law that helps people escape debt.

By , Attorney · University of the Pacific McGeorge School of Law

Bankruptcy works as a safety net for individuals, families, and businesses by helping them get back on their feet financially when overwhelmed by debt. For many, filing bankruptcy is a natural step after an unexpected event like a job loss, illness, or divorce. Bankruptcy relieves the stress associated with medical bills, foreclosure, credit card balances, and more.

So how can you use bankruptcy to get a fresh start? Start by learning:

  • how bankruptcy works
  • the three types of bankruptcy chapters
  • debts you can't erase in bankruptcy, and more.

Your goal? Determining the best bankruptcy chapter for you. Learning how bankruptcy works and understanding the three types of bankruptcy, Chapters 7, 13, and 11, are the first steps to getting the fresh start you need.

You'll find a basic overview of bankruptcy in the "How Bankruptcy Works" section. Then you'll learn the differences between bankruptcy Chapters 7 and 13, the two bankruptcy chapters most people file.

How Bankruptcy Works for You

Being bankrupt is the last thing anyone wants, but it happens. Fortunately, our legal system helps people start over by filing for bankruptcy.

Bankruptcy works by "voiding" or breaking the contracts between you and your bankruptcy creditors, freeing you from the responsibility of paying your bills. It's how bankruptcy can give you a fresh start.

But bankruptcy works for creditors, too. Keep reading to learn more.

How Bankruptcy Works for Creditors

Bankruptcy starts when you file completed bankruptcy forms with the bankruptcy clerk. In your bankruptcy filing, you'll explain everything about your financial situation, which in turn will reveal why you're bankrupt.

For instance, some of the things you'll tell the bankruptcy court will include:

  • how much you make
  • who you owe money and how much
  • all of the property you own
  • if you've sold or given away property
  • where you bank
  • if you have a storage space or safe deposit box, and
  • if anyone has filed a lawsuit against you.

The task of reading your bankruptcy paperwork will fall on the bankruptcy trustee the bankruptcy court appoints to oversee your case. If the bankruptcy trustee finds that you can pay some amount to your bankruptcy creditors, the bankruptcy trustee will follow the bankruptcy law to ensure each bankruptcy creditor gets the amount the creditor is entitled to receive.

How the bankruptcy trustee will pay creditors will depend on which one of three types of bankruptcy you file.

The Three Types of Bankruptcy: Chapter 7 Bankruptcy, Chapter 13 Bankruptcy, and Chapter 11

More than three types of bankruptcy exist, but bankrupt individuals and small businesses can file Chapter 7, Chapter 13, and Chapter 11. Here's a little about each type of bankruptcy.

  • Chapter 7 bankruptcy takes about four months to finish. Bankruptcy filers don't repay creditors but can lose property in this type of bankruptcy.
  • Chapter 13 bankruptcy takes three to five years to complete. Bankruptcy filers repay some or all of what they owe creditors and don't lose property in this type of bankruptcy.
  • Chapter 11 bankruptcy varies in length. Everyone involved works to restructure the filer's finances, and the filer usually pays creditors less. The filer might or might not sell property to facilitate a workable plan.

Keep reading for more information about each type of bankruptcy.

The Quickest Type of Bankruptcy: Chapter 7 Bankruptcy

Chapter 7 bankruptcy filings exceed all other types of bankruptcy every year by far, which isn't surprising because, when possible, most people prefer to file for Chapter 7. Why? Because it doesn't require creditor payments, and it's over in about four months.

However, all this stripped-down, bare-bones type of bankruptcy does is help people "discharge" or wipe out qualified debt, such as credit card balances, medical bills, and personal loans. It doesn't solve any other financial problems.

Chapter 7 bankruptcy works best for people who don't have much money left after paying monthly expenses and don't have more property than their state lets them protect or "exempt" with a bankruptcy exemption. Filers lose property they can't protect with a bankruptcy exemption.

Individuals and businesses can file this type of bankruptcy.

The Most Helpful Type of Bankruptcy: Chapter 13 Bankruptcy

Chapter 13 bankruptcy solves a lot more problems than Chapter 7 bankruptcy. Bankruptcy filers can use the three- to five-year repayment plan to catch up on mortgage payments and keep a house, or bring a car loan current and keep a car.

Also, Chapter 13 bankruptcy filers don't lose property. Instead, they can pay creditors to keep nonexempt property through the Chapter 13 plan.

This type of bankruptcy works best for bankruptcy filers who make too much to qualify for Chapter 7 bankruptcy or those who want to keep property they'd lose in Chapter 7 bankruptcy. Only individuals and sole proprietors qualify for Chapter 13 bankruptcy. Businesses and companies can't use this type of bankruptcy.

The Most Expensive Type of Bankruptcy: Chapter 11 Bankruptcy

Very few Chapter 11 bankruptcy cases get filed each year. Why? Because this type of bankruptcy is complicated, expensive, and usually filed by large and small businesses needing financial help from creditors. Individuals who have too much debt for Chapter 13 can also use Chapter 11.

You can learn more about Chapter 11 bankruptcy here.

Debts You Can't Get Rid of In Bankruptcy

You will have to pay for "nondischargeable debt" or debt that doesn't go away in bankruptcy. If you file for Chapter 7 bankruptcy, these debts will remain with you after your Chapter 7 bankruptcy ends. In Chapter 13, you'll pay most nondischargeable debts in full through your Chapter 13 plan (but not student loans).

These are the most common nondischargeable debts:

Before deciding you're bankrupt, make sure you can erase enough debt to make filing for bankruptcy worthwhile.

How to Decide Which Type of Bankruptcy Is Best

Your first step? Check whether your debts qualify for a bankruptcy debt discharge and if you can protect your property in your state using bankruptcy exemptions.

If you can, the next step is determining if you qualify for Chapter 7 bankruptcy by passing the bankruptcy means test. If you pass the Chapter 7 means test, you'll likely want to file for Chapter 7 bankruptcy, but always be sure to consult with a bankruptcy attorney.

If you don't qualify for Chapter 7 bankruptcy, or if you have other problems, such as you want to keep a home out of foreclosure or prevent your car from being repossessed, you'll likely want to consider filing for Chapter 13 bankruptcy.

Need More Bankruptcy Help?

Did you know Nolo has been making the law easy for over fifty years? It's true—and we want to make sure you find what you need. Below you'll find more articles explaining how bankruptcy works. And don't forget that our bankruptcy homepage is the best place to start if you have other questions!

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Chapter 7 Bankruptcy Overview

Filing a Chapter 7 Bankruptcy: Basic Steps

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How to File for Chapter 13 Bankruptcy

Consider Before Filing Bankruptcy

Chapter 7 Bankruptcy—Who Can't File?

What Are the Differences Between Bankruptcy Chapters 7 Bankruptcy and 13?

Is It Better to File Chapter 7 or Chapter 13 Bankruptcy?

When Filing Chapter 13 Bankruptcy Is Better Than Chapter 7

Helpful Bankruptcy Sites

Department of Justice U.S. Trustee Program

United States Courts Bankruptcy Forms

We wholeheartedly encourage research and learning, but online articles can't address all bankruptcy issues or the facts of your case. The best way to protect your assets in bankruptcy is by hiring a local bankruptcy lawyer.

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