Bankruptcy is a term used to define an entity or person that is unable to pay back debts owed to creditors. This is a legal status which is initiated by a court order (typically by the debtor).
The process is initiated with a debtor, or (less commonly) a creditor filing a petition. Once the petition is processed then the assets of the debtor are evaluated and measured. Any assets that the entity has are used to reduce the balance of the debts outstanding.
“A legal procedure for dealing with debt problems of individuals and businesses; specifically, a case filed under one of the chapters of title 11 of the United States Code (the Bankruptcy Code).”
During the 2008 financial crisis and the Great Recession that followed, US bankruptcy courts were extremely busy.
Once the proceedings of bankruptcy are completed, then the debtor is essentially relieved of the outstanding debt obligations that it had before filing for bankruptcy – he, she or it has a clean slate.
Despite there being a negative association with a business or person filing for bankruptcy, it can be a beneficial move as it provides them with a second chance – while at the same time ensuring a portion of the debt is paid back to creditors.
The term is derived from the Italian words banca rotta, which literally translates into ‘broken bench’ or ‘broken bank’.
Bankruptcy is not always the same as insolvency, as in different countries the term may only apply to specific entities.
In the UK, bankruptcy is only limited to individuals, whereas in the US it is used in broader contexts (including most forms of insolvency proceedings). In the UK, companies and other types of corporations enter into liquidation and administration.
Bankruptcy in the US
According to Title 11 of the United States Code, there are six types of bankruptcy in the US:
Chapter 7: this is the quickest form of bankruptcy (often referred to as straight bankruptcy). It involves basic liquidation for individuals and businesses.
Chapter 9: a federal mechanism to resolve municipal bankruptcy (incurred by municipal debts).
Chapter 11: this is known as corporate bankruptcy. It allows for the rehabilitation or reorganization by business debtors or by individuals with substantial debts and assets. It gives an entity a chance to continue operating, as long as it follows a strictly imposed debt repayment plan.
In December, 2014, teen retailer Delia’s announced that it would liquidate all of its stores and file for Chapter 11 bankruptcy protection.
Chapter 12: rehabilitation for family farmers and fishermen.
Chapter 13: commonly known as Wage Earner Bankruptcy. This form of bankruptcy allows people with a regular income to develop a plan to repay their debts.
Chapter 15: focuses on ancillary and other international cases of bankruptcy aimed at helping foreign debtors clear debts.
A growing number of seniors in Canada are declaring bankruptcy, according to a study by the Financial Consumer Agency of Canada published in 2014. Over much of North America, people are entering retirement carrying a greater burden of debt compared to previous generations.
The history of bankruptcy
The concept of bankruptcy and the subsequent consequences are believed to trace back to the 13th century in a law included in the Yassa (a code of law created by Genghis Khan), under which a person who went bankrupt three times would face the death penalty.
In the Western world, the first statute dealing with bankruptcy and insolvency was an Act passed by the Parliament of England in 1542, called The Statute of Bankrupts (An Acte againste suche persones as doo make Bankrupte, 34 & 35 Henry VIII, c. 4).
“How did you go bankrupt?”
“Two ways. Gradually, then suddenly.”
(Ernest Hemingway, The Sun Also Rises)
The term can also be used in non-financial situations. Here is a quote from the American actor, writer, director, comedian and playwright Woody Allen:
“His lack of education is more than compensated for by his keenly developed moral bankruptcy.”
Video – What you should know before filing for bankruptcy