So What is Bankruptcy... Really?
One of the biggest misconceptions about bankruptcy is the word “bankruptcy” itself. It’s worth first noting, Bankruptcy isn’t a “thing”… Bankruptcy is a legal process, enacted by Congress, by which any person (called a “debtor”) can find relief from some, if not all, of their debts. Federal bankruptcy laws were enacted in order to help give those in need a financial “Fresh Start” from overwhelming and burdensome debts. The US Supreme Court highlighted the purpose of federal bankruptcy laws when it held, “[Bankruptcy] gives to the honest but unfortunate debtor…a new opportunity in life and a clear field for future effort, unhampered by the pressure and discouragement of preexisting debt.” (Local Loan Co. v. Hunt, 292 U.S. 234, 244 (1934))
How does Bankruptcy Help?
The financial “Fresh Start” that a debtor seeks by filing a bankruptcy case comes in the form of the Court ordered discharge of debts, also called a bankruptcy discharge. A bankruptcy discharge essentially releases a debtor from the personal liability to repay specific debts. In other words, the debtor is no longer legally required to pay any debts that are discharged. A bankruptcy discharge is a permanent order prohibiting a debtor’s creditors from taking any further collective actions on discharged debts, including legal action and communications with the debtor, such as telephone calls, letters, and personal contacts. Because a bankruptcy discharge is a permanent statutory injunction, creditor can be sanctioned by the court for violating the discharge injunction.
The Various "Types" of Bankruptcy
Another common misconception about bankruptcy is that it is a "one size fits all" process. For instance, you've probably heard stories of companies, famous celebrities, and even friends or family who filed bankruptcy at some point. What may not be known about these famous (and not so famous) bankruptcies, is what "type" of bankruptcy, or "Chapter" of bankruptcy was filed? Generally speaking, there are five different "Chapters" (ie. types) of bankruptcies, including Chapter 7 (“Liquidation”), Chapter 9 (“Municipality Bankruptcy”), Chapter 11 (“Reorganization”), Chapter 12 (“Family Farmer/Fisherman Bankruptcy”, and Chapter 13 (“Individual Debt Adjustment”). When you hear about a corporate or so called “celebrity” bankruptcy, the type of bankruptcy involved is most often the Chapter 11 (“Reorganization”) bankruptcy. Even though these high profile Chapter 11 bankruptcies often make the headline news, they are not very common. In fact, the two most common bankruptcies filed by individuals and families are Chapter 7 and Chapter 13 bankruptcies, with Chapter 7 bankruptcies being the most common of the two.
Chapter 7 vs Chapter 13: What's the difference?
A Chapter 7 bankruptcy is informally known as a “simple 7” given it tends to be the most straightforward of all the various types of bankruptcies, and usually is completed in the shortest amount of time (+/- 4 months from filing to discharge of debts). A Chapter 13 bankruptcy on the other hand, commonly known as the personal reorganization chapter, is significantly more complex than a Chapter 7. Both Chapter 7 and Chapter 13 bankruptcies will immediately stop collection actions by creditors, giving the filing individual(s) breathing room to financially re-group. Both Chapter 7 and Chapter 13 bankruptcies will also, upon successful completion, lead to a bankruptcy discharge and a financial Fresh Start.