Bankruptcy

Background

Enron. WeWork. Lehman Brothers. Bed Bath & Beyond. These famous corporate failures represent some of the nearly 500,000 bankruptcy filings that happen each year in the United States.

For these big businesses—and for everyday individuals, local governments, and even farms and fisheries—bankruptcy can provide a way to tackle crushing debt. It’s a legal process that allows debtors to negotiate and repay money owed. For some, it’s a way to get out of debt entirely.

Types of Bankruptcy

Bankruptcy isn’t for $500 sitting on a credit card or for routine bills. It’s a solution for extreme debt that a company or individual is unable to repay. Specifically, it offers a lifeline when debtors start to face lawsuits, garnished wages, and pending evictions.

What the bankruptcy process actually looks like is determined by the type of filing a business or individual pursues.

The three most popular types are Chapter 7, Chapter 11, and Chapter 13, with names referring to specific sections of the US bankruptcy code.

Chapter 7 is the most common for individuals, requiring filers to sell off their assets to help repay debts. It’s possible that an individual could make too much money to be eligible for Chapter 7, however. In this case, they may turn to Chapter 13, which lets debtors work on a repayment plan over three- to five-year periods.

Chapter 11 is a popular option for businesses. It allows companies time to restructure their liabilities and come up with a repayment plan. Companies that have filed are able to remain operating while working through the court process.

How It Works

Each type of bankruptcy filing has its own process, although they share many of the same elements.

In Chapter 7, for example, debtors must first establish their filing eligibility. One requirement is that individuals may not make multiple filings too close together. Filers also must pass an income means test—essentially proving that their monthly income is below their state’s median.

Once a debtor has determined that they are eligible, the next step is to begin the paperwork associated with the filing. Most experts recommend that individuals hire a lawyer to help with these proceedings, as they can be complex.

After the paperwork has been turned in, the bankruptcy court verifies what a debtor has submitted, and filers will then go before the court for a meeting to review their claims.

In Chapter 7, filers will sell off assets like family heirlooms or investments to pay back what they owe. If they have debt on large purchases like furniture, they may need to return those items. Once this has been done, or if filers have no qualifying assets to sell, the court can “discharge” or erase the rest of the outstanding debt.

Consequences of Bankruptcy

Because a bankruptcy filing indicates that someone is unable to make payments on their debt, it can lower an individual’s credit score by as much as 200 points.

The process also doesn’t eliminate all debt. For instance, alimony and child support payments are not eligible for discharge. And, after the Chapter 7 or Chapter 13 process wraps up, debtors could still face foreclosure.

In corporate bankruptcies, common stockholders are the first to suffer. The process prioritizes all other creditors—so if you have stock in a company that files for Chapter 11, your investment is likely going to zero.