Bankruptcy Settles Debts, But With Consequences

When people or businesses become heavily in debt and cannot meet their financial obligations, declaring bankruptcy is sometimes the only solution.

Bankruptcy is a federal law that provides the person or business an orderly way to settle the debts and begin anew. For the creditors, bankruptcy enables them to receive all, part or none of the debt owed.

A person or business declares bankruptcy by filing a petition for relief in U.S. Bankruptcy Court. An individual usually files for bankruptcy under either Chapter 7 or Chapter 13. Chapter 7 bankruptcy, known as straight bankruptcy, calls for the liquidation or sale of the debtor's non-exempt possessions to repay creditors. Chapter 13 bankruptcy is known as wage earner's bankruptcy because it calls for the debtor to repay the debt in installments over a period of time from his or her excess or disposable income.

Chapter 11 bankruptcy, commonly known as business reorganization, is often complex and expensive, involves large debts, and occurs when the person or business wishes to retain the assets, remain in business, and reorganize financially. A creditor may ask the court to appoint a trustee if the debtor has been found guilty of fraud, dishonesty, incompetence, or gross mismanagement.

Chapter 12 of the bankruptcy law offers special protection to farmers. It prevents foreclosure on a farmer's real estate debts during economic slumps. The farmer retains possession of the land and continues to operate the farm. To settle the debts, he usually devotes the profits from future crops.

Declaring bankruptcy does not erase all types of debt. A debtor may still liable for tax claims, alimony, child support, property settlements, most student loans, and claims for punitive damages.

While bankruptcy may appear to be an easy way to erase debts, it does come with consequences. A person who has declared bankruptcy will have that fact on his or her credit report for 10 years. Such credit history can lead to other financial problems like the inability to get a loan for a car, a house mortgage, or even a credit card. A consumer credit counselor or bankruptcy attorney can advise a person on the best way to settle his or her debts, possibly without declaring bankruptcy.