Filing Bankruptcy: What Is It & How Does It Work?

When someone is in debt and can’t see a way out, they can file for bankruptcy. If they’re a corporation, a small business, an individual or even a municipality, there is a bankruptcy filing for their circumstance.

While bankruptcy may not feel like the best option for a debtor, through the bankruptcy court process they can find relief from incessant phone calls of creditors, pay down their debt and not lose their assets. Chapter 7 and Chapter 11 bankruptcies are the most common forms of bankruptcies for individuals.

The bankruptcy process allows those whose debts have become overwhelming a way to pay them without losing their assets. Through this process, a judge and a bankruptcy trustee examine the filer's assets, as well as their income and liabilities.

From the filing and its subsequent investigation, the court and the bankruptcy trustee make a decision to discharge or forgive the filer’s debts. A bankruptcy court may dismiss a case altogether, if it does not believe the filer is capable of paying down their debt or if the filer skips some of the steps in the process.

Filing for bankruptcy may not seem like the best option for debtors, but it can offer relief from creditors, while allowing the debtors to pay down their debt.

However, it can also make it harder for the debtor to rebuild their credit. Bankruptcy filings are public information and can affect filers in a variety of ways, for example when trying to secure a car loan or renting an apartment.

People from all walks of life and all income levels file for bankruptcy.

Nearly half a million bankruptcy cases were filed in 2021 alone. Of those, just over 14,000 bankruptcy cases were filed by businesses. Most individuals filing for bankruptcy are not rich; those filing Chapter 7 and Chapter 13 bankruptcies are typically low- to medium-wage earners.

There are any number of reasons that someone files for bankruptcy. Debts can stem from unavoidable circumstances or as the result of decisions outside of the filer's control.

Some reasons for filing a bankruptcy petition include:

• ‌Divorce:‌ The cost of a marriage dissolution and corresponding legal fees can be high.
• ‌Illness and medical bills:‌ According to an ‌American Journal of Public Health‌ report from 2019, 65 percent of bankruptcy filings in the U.S. were the result of medical expenses.
• ‌Bad financial decisions:‌ Overusing credit cards is a common reason debtors file for bankruptcy.
• ‌Job loss and lack of income:‌ Many Americans don’t have savings, and without income, debts pile up quickly.
• ‌Unexpected emergencies:‌ These include events like theft, fire or natural disasters.

There are six types of bankruptcy chapters in the United States Bankruptcy Code: Chapters 7, 9, 11, 12, 13 and 15.

The most common types are Chapters 7 and 13. Each bankruptcy chapter meets the different circumstances of the party filing. They are:

This chapter is for individuals who cannot make regular payments toward their debts and for businesses terminating their enterprises. It is based on the amount a filer owes and whether they are solvent (assets in excess of liabilities) or insolvent (total liabilities exceed total assets.) A Chapter 7 filer takes a means test to determine their income.

This type of bankruptcy case gives financially distressed municipalities protection from creditors.

Also called “reorganization bankruptcy,” this allows debtors to restructure their assets, business affairs and debts. Companies typically remain open for business under Chapter 11

This type of bankruptcy was created for financially distressed family fisherman and farmers.

Known as the “wage-earner’s" bankruptcy, Chapter 13 allows individuals with a regular income to restructure their debt and pay all or some of their creditors.

Added to the Bankruptcy Code in 2005, Chapter 15 allows U.S. courts and foreign courts to work together when foreign bankruptcy filings affect domestic financial interests.

The debtor can file for bankruptcy on their own or with the help of a bankruptcy lawyer. Attorney and filing fees are part of a bankruptcy filing; if the party files on their own, without the help of a bankruptcy lawyer, they still have to pay the filing fees.

Those who can’t afford an attorney can find local and free legal services in their area. To do this, they can contact the American Bar Association or their local bar associations for information.

Before starting the bankruptcy filing process, the debtor should learn about bankruptcy's advantages and disadvantages. The process, which includes filing forms and preparing supporting documents to show the bankruptcy trustee, may be confusing and complex.

Before filing a bankruptcy petition, the debtor will:

A debtor will list their assets, debts, expenses and income.

Doing this will not only give them a greater understanding of their finances, but their bankruptcy attorney, trustee and the court will also have a better understanding of their circumstances.

This will take place for at least 180 days before filing a bankruptcy petition, which is required by the court.

This assures that the debtor has exhausted all possibilities to pay down debt before they file.

Credit counseling agencies must be listed on the U.S. Courts site and many offer services online or by phone. Once the debtor finishes credit counseling, they get a Certificate of Completion from the court, which becomes part of their filing.

If they skip credit counseling, the court will reject their bankruptcy petition.

Again, the debtor may hire a bankruptcy lawyer if they need one, but the court does not require them to do so. If they file on their own, understanding state and federal bankruptcy laws is paramount to a successful case; judges and court employees cannot offer any guidance by law.

Knowing how to fill out the bankruptcy forms is another matter – not doing so correctly can affect the case’s outcome. Legal advice is, therefore, often advised.

The moment the debtor’s bankruptcy filing begins, the court issues an automatic stay, a court order prohibiting creditors from contacting the filer to collect their debts. The bankruptcy court will send out a Notice of Filing and a Notice of Stay to the applicable creditors, making it illegal for them to begin or continue to collect on a debt.

During an automatic stay, creditors can reach out only to the debtor’s attorney if they have one; they cannot contact the debtor directly. Some types of debts are not protected by an automatic stay.

For example, child support and alimony payments, and money owed due to criminal proceedings are exemptions.

When the bankruptcy petition is accepted by the court, and the debtor's case is assigned to a bankruptcy trustee, the filer will meet with creditors through that trustee.

In Chapter 7, 12 and 13 bankruptcy cases the court appoints the trustee. In a Chapter 11 case, a U.S. trustee representative conducts the meeting. The debtor must attend the meeting, which typically takes place 20 to 60 days after the bankruptcy filing, but it is optional for creditors.

The trustee may ask questions of the debtor regarding the case, such as:

• Is the address on the petition the filer’s current residence?
• Did the debtor sign all documents related to the bankruptcy filing?
• Did the debtor read and understand all the documents of the bankruptcy filing before signing them?
• Is the information in the documents true and correct to the best of their knowledge?
• Did the filer identify all assets and list all creditors in the documents?
• Has the debtor filed for bankruptcy at an earlier date?

If the bankruptcy trustee finds that the debtor has answered all questions and that their documents are satisfactory, they will conclude the meeting of creditors. If they not, they can schedule a continuance to gather more information.

The process of a bankruptcy discharge is different from chapter to chapter. In a Chapter 7 bankruptcy, the debtor files a debtor education certificate.

In a Chapter 13 bankruptcy, the debtor will go to a repayment confirmation hearing to get confirmation of their repayment plan and will make payments to their creditors over the next three to five years.