Bankruptcy May Occur When People or Businesses

Bankruptcy may occur when people or businesses that are financially-distressed may have their debt eliminated in part or altogether. The number of bankruptcy filings for the fiscal year ending March 31, 2003 was ~1.6 million in the United States alone (Levy and LaGana). Common types of bankruptcy include filing Chapter 7, 11, 12, or 13. Chapter 7 is the most common type of bankruptcy and may be used by people or businesses. Chapter 13 bankruptcy is limited to people only. Chapter 11 and Chapter 12 bankruptcy are much less common and will not be discussed in this report.

With a Chapter 7 bankruptcy, a court-appointed trustee will divide the debtor's property into "exempt" and "non-exempt" property (Taylor). The trustee will sell all of the debtor's non-exempt property and use the money to pay off the debtor's unsecured creditors. Secured creditors are protected by their security interest in the debtor's property (called collateral). If a debtor stops making payments, the secured creditor can take possession of the debtor's collateral. Once the exempt property is liquidated and distributed among the unsecured creditors, the remaining unsecured debt is discharged. However, some types of unsecured debt, including student loans, child support, and taxes, cannot be discharged, even in a bankruptcy proceeding.

In a Chapter 13 bankruptcy proceeding, the debtor may develop a plan to repay both secured and non-secured creditors over a period of several years (Taylor). Chapter 13 provides a means to catch up on payments without the threat of foreclosure or repossession. One must have an income that exceeds the person's reasonable living expenses to qualify for Chapter 13 bankruptcy. This is so the individual has a means of repaying the past debts to creditors. At the end of the repayment period, the debtor's outstanding debts are eliminated.