Bankruptcy is a legally declared inability or impairment of ability of an individual or organisation to pay their creditors. A declared state of bankruptcy can be requested or initiated by the bankrupt individual or organisation, or it can be requested by creditors in an effort to recoup a portion of what they are owed.
The primary purpose of the laws of bankruptcy are: (1) to give an honest debtor a "fresh start" in life by relieving the debtor of most debts, and (2) to repay creditors in an orderly manner to the extent that the debtor has property available for payment.
Bankruptcy allows the debtor to resolve his debts through the division of his assets among his creditors. Additionally the declaration of bankruptcy allows debtors to be discharged of most of the financial obligations, after their assets are distributed, even if their debts have not been paid in full. During the pendency of a bankruptcy proceeding, the "Debtor" is protected from extra-Bankruptcy action by creditors by a legally imposed "stay."
Bankruptcy in the United States
Bankruptcy is federal statutory law (Title 11 of the United States Code) based upon the Constitutional requirement for "uniform laws on the subject of Bankruptcy throughout the United States." (Article I, Section 8). Bankruptcy proceedings are undertaken in the United States Bankruptcy Courts, part of the District Court system.
There are several types of proceedings that fit under the general category bankruptcy. The U S Bankruptcy Code has multiple chapters, each describing a different procedure available for debt resolution. Liquidation under a Chapter 7 filing is the most common form of bankruptcy. Liquidation involves the appointment of a trustee who collects the non-exempt property of the debtor, sells it and distributes the proceeds to the creditors. Bankruptcy under Chapter 11, Chapter 12, or Chapter 13 is more complex and involves allowing the debtor to use future earnings to pay off creditors. In addition, there is Chapter 9 bankruptcy. This Chapter is available only to municipalities. Perhaps the most famous example of a municipal bankruptcy was in Orange County, California. Chapter 9 is a form of reorganization, not liquidation. Another chapter is for farm bankruptcies.
Bankruptcy can be entered into voluntarily by the debtor. It can also be commenced involuntarily by three or more creditors under certain circumstances.
Some property is exempt from being sold to pay debts in a bankruptcy. The law varies, but in many states, exempt property includes equity in a home or car, tools of the trade, and some amount of personal effects. One major purpose of bankruptcy is to ensure orderly and reasonable management of debt. Thus, exemptions for personal effects prevent punitive seizures of personal items of little or no economic value (diary, toothbrush, ordinary clothing), since this does not promote any desirable economic result. Similarly, tools of the trade are protected to allow the insolvent debtor to move forward into productive work as soon as possible.
Not every debt may be discharged. Monies owed to the federal government, such as taxes and guaranteed student loans are not dischargeable. Secured debt, such as a mortgage or mechanics lien on a home, are generally not "discharged", or cancelled, in a bankruptcy, although there exist certain exceptions (See also lien avoidance). Also, any debt tainted by one of a variety of wrongful acts recognized by the Bankruptcy code, called defalcation, cannot be discharged.
