A legal proceeding initiated by an individual or company that is unable to pay its debts. A bankruptcy can either liquidate the debts or attempt to develop a reorganization plan under which the debt, or some of it, will be paid. The most common type of bankruptcy filing is Chapter 11, in which a business is allowed to continue running while it reorganizes its debts. Creditors are prevented from attempting to collect debts from a company that is in a Chapter 11 bankruptcy proceeding. In a Chapter 11, the debtor and creditors meet to draw up an agreement for repaying some of the debt.
Some companies close down through a Chapter 7 bankruptcy (also called a liquidation), instead of attempting to reorganize. In a Chapter 7 bankruptcy, a court-appointed interim trustee is given discretion to make management changes, arrange unsecured financing, and wind down the business. Individuals who want to get rid of their debt and not attempt to pay anything back file for Chapter 7 bankruptcy.
Individuals who want to reorganize their debts and pay back a portion file for a Chapter 13 bankruptcy. Typically, people who make this type of filing pay something each month for several years to the bankruptcy court, which distributes the funds to the creditors. When the payments are completed, the debtor’s debts are discharged. Chapter 13 bankruptcies allow individuals to hold onto more assets than Chapter 7 bankruptcies do.
Bankruptcies fall into two categories. A voluntary bankruptcy occurs when the debtor petitions the court to begin a bankruptcy proceeding. An involuntary bankruptcy occurs when the creditors petition the court to put the debtor into bankruptcy. The term chapter refers to the chapter of the bankruptcy law where the provisions are outlined.