Where it is a person who cannot pay their debts, the person's creditors may ask the court to appoint a trustee in bankruptcy. This is a professional accountant who is appointed by the court, to take control of the bankrupt person's assets. Some assets are protected by law, but the trustee in bankruptcy will sell off all of the other assets and use the money to pay as much of that person's debts as possible. After the process is complete the person is discharged from bankruptcy, and the person is free from any further liability to pay those claims, but normally that person will be limited in their ability to borrow money again because their credit rating will be damaged.
Where it is an organisation who cannot pay their debts, the creditors may ask the court to appoint a liquidator. The liquidator does a very similar job to the trustee in bankruptcy except that there are no assets which are protected so the liquidator can sell everything. Once all of the assets of the organisation have been sold, the organisation is then dissolved and no longer exists. Organisations do not get discharged from bankruptcy in the same way that a living person does.
Insolvency or bankrupcy
People often confuse the terms bankruptcy and insolvency, and sometimes they use one word when they really mean the other. Insolvency usually just means that a someone does not have enough money to pay their debts or (sometimes) that the total amount of their debts is worth more than the total amount of their assets. Bankruptcy is a formal legal process in front of the courts. Although the two terms are connected, just because a person is insolvent does not necessarily mean that they will go into bankruptcy.
Alternatives to bankruptcy
Many countries have alternatives to bankruptcy to try and allow people and businesses to try and avoid the bankruptcy process.
In various countries, individual people can try and reach individual voluntary arrangements (or IVAs) with their creditors. This means that the creditors agree to take less money to discharge their debts. There are similar processes for companies and other organisations, and they go by various different names in different countries, but in many countries they are called schemes of arrangement.
In many countries a company or business can ask the courts for bankruptcy protection to try and protect the business so that the creditors cannot destroy all of the physical capital and goodwill by breaking it apart and moving it away. The aim of this is provide is more time for the business to reorganise itself and to work out a new deal between the owners and the people the business owes money. In many countries this is called going into administration.
However, not all countries have bankruptcy protection laws for businesses.
Often a creditor threatens a debtor with debt slavery in many parts of the world. In some cases the debtor does not know that they have a right to go bankrupt. This is a human rights problem in some countries. Also, some creditors continue to harass a debtor even though bankruptcy laws say they should not, hoping that the debtor will pay them money that they do not deserve.
Bankruptcy in the United States falls mostly under federal law, Title 11 of the United States Code (Bankruptcy Code). The types of bankruptcy available in the United States are named after the primary divisions, or "chapters", of that law. The person or business that files a bankruptcy case is known as the debtor.
When a bankruptcy case is filed, a trustee is chosen by the court. The trustee has authority over the property of the bankrupt person or business and may use some of the debtor's assets to pay the creditors. After a bankruptcy is filed, creditors are notified that they are to stop trying to collect money directly from the debtor and are to make claims for payment to the bankruptcy court.
The most common form of bankruptcy is the Chapter 7 Bankruptcy, which can be filed by businesses or individuals. It is also called liquidation bankruptcy because some of a debtor's property may be sold (liquidated) to satisfy creditors.
When a business is in debt and cannot pay it, it may ask or be forced to file bankruptcy in court under Chapter 7. A chapter 7 usually makes a company stop doing business. Employees often lose their jobs when company files for chapter 7.
Chapter 11 bankruptcy is a complicated type of bankruptcy that reorganizes the debtor's finances, usually reducing the amount of debt owed and changing debt repayment terms. A Chapter 11 bankruptcy case allows a business to keep running while it finds ways to reduce and arrange payment of its debts.
Almost all Chapter 11 bankruptcies are filed by businesses. Ordinary people do not usually file Chapter 11 bankruptcy, because a Chapter 13 bankruptcy will almost always be cheaper and easier for them.
Chapter 13 is the most popular form of bankruptcy in the United States for ordinary people. In a Chapter 13 bankruptcy some of your debts may be forgiven (discharged), but you will have to pay back a portion of your debt. The debt repayment plan is supervised by the bankruptcy court and usually lasts for three to five years. Businesses cannot file for Chapter 13 bankruptcy.
Other bankruptcy chapters
Less common forms of bankruptcy may be filed under Chapter 9 and Chapter 11 of the bankruptcy code.
- Chapter 9 bankruptcy allows municipalities, smaller units of government such as cities and towns, to restructure their debts.
- Chapter 12 bankruptcy is a special type of bankruptcy for family farms and fishermen. It combines elements of Chapter 11 and Chapter 13 bankruptcy to allow smaller farms and fishing businesses to stay open while they restructure their debts.