Increasing competition, poor management, and insufficient cash flow are some of the most common reasons businesses file for bankruptcy. But what exactly is bankruptcy? Here are some definitions of the different types of bankruptcies and examples of how they may play out.
So what is bankruptcy and how does it work?
Bankruptcy is a legal proceeding initiated by a person or a business that is unable to pay back its debts. The process is designed to allow people who are unable to repay their debts to start afresh, while still granting creditors the opportunity for some repayment.
Debtors wishing to file for bankruptcy must first fulfill the requirements for filing for bankruptcy. They must file a petition with the federal court and meet all the conditions, such as credit counseling in the last 180 days. Then the process will vary depending on the bankruptcy type (called chapter) which they file.
A bankruptcy is considered to be discharged when the proceedings are complete. A bankruptcy discharge is a court order which releases the debtor from liability for certain debts. The discharge only occurs after the debtor has satisfied all requirements of the bankruptcy agreement, including repayment plans. All debt on a discharge order is wiped out and no creditors can collect a discharged debt.
Types of Bankruptcy
There are six types of bankruptcy, also known as chapters:
- Chapter 7 bankruptcy, also known as liquidation, is the most common type of bankruptcy chapter for individuals. The court appoints a person, called a trustee, to take charge and who then sells all non-exempt property. The money from the sale is then split among the creditors so that they may recoup some of their losses. This is oftentimes only used as the last resort.
- Chapter 13 bankruptcy, also known as the wage earner’s plan, allows individuals with enough income to come up with a repayment plan to repay their debts within 3-5 years (extended to 7 years due to the Covid-19 crisis).
- Chapter 11 bankruptcy is typically used by big businesses and is complicated and expensive. A business proposes a reorganization plan that allows it to continue operating while repaying its debts.
- Chapter 15 bankruptcy is used when the cases span across borders. It is filed by foreign debtors as an ancillary proceeding in addition to a primary bankruptcy action pending in their home country.
- Chapter 12 bankruptcy is used by family farmers and fishermen.
- Chapter 9 bankruptcy is used by municipalities and political subdivisions.
The two most common types of bankruptcy are Chapter 7 and Chapter 13.
What happens if someone owes you money and they file for bankruptcy?
The Bankruptcy Court will notify you that your debtor filed for bankruptcy. It will send you a bankruptcy notice.
- Respect the Automatic Stay
You must respect the Automatic Stay. The Automatic Stay is a legal provision that takes effect the instant a debtor files for bankruptcy. When the Automatic Stay is in place, you cannot:
- Send the debtor phone calls asking for the money;
- Send the debtor demand letters or invoices;
- Initiate or continue court proceedings against the debtor;
- Initiate or enforce a lien against the debtor’s property;
- Attempt to foreclose on the debtor’s property.
If you take any of these actions, the debtor can sue you and you risk losing more than your claim is worth.
- File a Proof of Claim
You should also file a Proof of Claim. A proof of claim is an official bankruptcy form that creditors must file to obtain money from the bankruptcy trustee. A proof of claim sets out the basis and amount of the creditor’s claim against a debtor. You can download the official 410 Proof of Claim form here.
The filing deadline for the proof of claim is called the bar date. The bar date differs depending on the type of bankruptcy: Chapter 7 and 13 bankruptcies have different requirements from Chapter 11 bankruptcies.
If you are owed money under a Chapter 7 or 13 bankruptcy, the deadline for filing a proof of claim is 70 days after the bankruptcy petition filing date.
By contrast, if you are a creditor under a Chapter 11 bankruptcy, there is no need to file a proof of claim, as the debtor must file a Schedule of Assets and Liabilities. As a measure of precaution, it is advisable, however, to file a proof of claim anyway. It is only if the Schedule lists the incorrect amount of your claim, wrongly categorizes it, or designates the claim as disputed that you are required to file a proof of claim. Failure to do so means the Bankruptcy Court will only make distributions according to the debtor’s Schedule of Liabilities. This could mean, for instance, that you could recover less money.
Bankruptcy is not necessarily a bad thing
Bankruptcy has a poor reputation among creditors. Yet if your debtor is in this situation, do not despair.
First, you could still be repaid some of the money you are owed. A person who declares bankruptcy will indeed not necessarily get out of all debt. It depends on which bankruptcy chapter is applicable. If Chapter 13 applies, then the debtor will have to repay an agreed portion of their debt, but within a time period of 7 years. After 7 years, any remaining debt will be discharged. Under Chapter 7, some debts will be paid off by selling some of the debtor’s assets. Additionally, there are some debts that must be paid regardless of the bankruptcy chapter (7 or 13). These include alimony, child support, and debts that the debtor did not list when they declared bankruptcy.
Secondly, although there is an automatic stay, you might qualify to get around it and get paid sooner.
Thirdly, if you are a secured creditor, you are likely to recover some of the money you are owed, as your claim is prioritized in repayment. You are a secured creditor if you have a lien over certain assets of your debtor. A lien is a legal claim against a property that you have until the debt is paid off. If a debtor fails to pay their debts, you can ask the court to take the asset with a lien and collect the amount you are owed. With the money from the sale of your debtor’s assets, your debt will be paid. You are therefore better protected than unsecured creditors against the risk of non-repayment.
How does bankruptcy work in different countries?
In the UK, bankruptcy only applies to individuals. A different process, known as liquidation, applies to companies. There are three types of liquidation: creditors’ voluntary liquidation (the company cannot pay its debts and involves creditors in the liquidation process), compulsory liquidation (the company cannot pay its debts and applies to the courts to liquidate it) and members’ voluntary liquidation (the company can pay its debts, but it wishes to liquidate).
In France, different regimes for bankruptcy apply depending on whether or not the debtor runs a business. For a business, bankruptcy is triggered whenever a company cannot pay its debts. There are two types of insolvency proceedings: amicable (can only be initiated by the debtor) and judicial (opened by the Court).
Bankruptcy is therefore the judicial proceeding for people or companies who are unable to repay their debts. There are various types of bankruptcies, each impacting how much money you will get back if any. If you are owed money by a bankrupt entity, we can help. Write to us here.