Bankruptcy is the state of being legally unable to pay debts. The term also refers to the legal process applied to those who are unable to pay debts. A court may declare both individuals and businesses to be bankrupt. The indebted person or business involved in bankruptcy proceedings is usually called the debtor, or sometimes the bankrupt. People or businesses that are owed money are called creditors. During bankruptcy proceedings, the debtor is restricted in financial and business affairs. In addition, the debtor’s assets and property may be sold as part of a settlement with creditors. Bankruptcy may also lead to criminal charges if there is evidence of fraud or financial misconduct. Bankruptcy laws vary from country to country.
The term bankrupt comes from an Italian word meaning broken bench. An old Italian custom supposedly called for breaking the benches or tables of bankers and moneylenders whose businesses had failed.
Features of bankruptcy.
The laws of many countries divide bankruptcy into two main categories, voluntary and involuntary. Voluntary bankruptcy occurs if a debtor requests to be declared bankrupt. Involuntary bankruptcy occurs if a debtor’s creditors ask that the debtor be declared bankrupt. A court may declare a debtor involuntarily bankrupt if the debtor is _insolvent—_that is, unable to pay debts as they become due.
Many bankruptcy proceedings involve the process of liquidation. Liquidation is the settling of a debtor’s accounts by converting the debtor’s assets into cash. During a typical liquidation, an uninvolved party—sometimes called a receiver, assignee, or trustee—_sells the property and distributes the proceeds among the creditors (see Receiver ). These payments to the creditors are sometimes called _dividends. The money obtained from the liquidation may also pay for such expenses as court costs and receivers’ fees. Under some conditions, a debtor may be allowed to keep certain possessions as exemptions from the liquidation process.
In many cases, liquidation does not raise enough money to fully repay the debts owed to creditors. In such cases, creditors typically receive shares of whatever proceeds are available. Certain debts have priority over other debts. These priority debts include wages owed to employees and taxes owed to the government. They may also include debts from secured loans—_that is, loans backed by _collateral (property promised to the creditor if the loan is not repaid). If money remains after the priority debts have been settled, the remaining creditors usually receive payments in proportion to the amounts they are owed.
Following bankruptcy proceedings, the debtor is usually discharged (freed) from remaining debts. A discharge gives the debtor a chance to make a new financial start. However, a full discharge of debts may be denied under certain circumstances. In many countries, certain types of debts—such as alimony, child support, and taxes—cannot be discharged.
In the United States,
the Constitution authorizes Congress to establish uniform bankruptcy laws throughout the country. However, many state laws also regulate bankruptcy procedures. The main federal bankruptcy law is the Bankruptcy Reform Act of 1978—commonly called the _bankruptcy code—_which updated the Bankruptcy Act of 1898. Bankruptcy courts handle all petitions for bankruptcy. The U.S. Trustee Program, an organization within the Department of Justice, assists with many of the duties of bankruptcy cases.
In personal bankruptcies, debtors generally have two options. They may seek a liquidation of their debts under Chapter 7 of the bankruptcy code, or they may seek rehabilitation under Chapter 13. Under Chapter 7, the debtor turns his or her assets over to the trustee to be distributed to creditors. Under Chapter 13, the debtor keeps control of the assets and sets up an agreement to repay the debt over time. Various factors—including the debtor’s regular income and the amount of money owed—determine which bankruptcy options a person may pursue.
Businesses filing for bankruptcy also have options. They may seek liquidation under Chapter 7, or they may seek reorganization under Chapter 11. Under Chapter 7, a trustee sells all of the firm’s assets and distributes the proceeds to creditors. Corporations that file for bankruptcy under Chapter 7 cannot exempt any of their property, and they cannot receive a full discharge of unpaid debts. Under Chapter 11, the firm’s managers continue to operate the firm while negotiating with creditors over how the debts will be repaid. The firm then proposes a reorganization plan, and creditors vote on whether to accept the plan. The plan must also be approved by the bankruptcy court. In addition to businesses, individuals whose debts exceed the limits for Chapter 13 bankruptcy may also file under Chapter 11.
During bankruptcy proceedings, a legal condition called an automatic stay takes effect. The automatic stay prohibits creditors from taking any action to recover the debts beyond the limits of the bankruptcy process.
In other countries.
Many countries—including Australia, Canada, and Mexico—have bankruptcy laws generally considered favorable for debtors. Such countries usually provide for automatic stays during bankruptcy proceedings. Such countries also allow managers of bankrupt companies to keep their jobs while seeking reorganization. In the United Kingdom and some other countries, bankruptcy laws are considered more favorable for creditors. British common law does not provide for automatic stays, and managers of bankrupt firms are typically removed during reorganization.
The bankruptcy laws of Germany involve a combination of approaches. They do not provide for automatic stays, but they do allow management to stay in place during reorganization. In general, German courts are less actively involved in the bankruptcy process than courts in most other countries.
