Commercial Law

What is Bankruptcy?

Everyone knows – at least generally – what it means when a person is “bankrupt.” It means that a person no longer has the money to pay off their debts. But what, exactly, does “bankruptcy” mean, in a legal sense? This article is intended to provide an answer to that question as well as a very brief introduction to the two major forms of bankruptcy that are available to individual consumers: “Chapter 7” and “Chapter 13.”

Readers who would like to learn more about bankruptcy are invited to follow the links at the end of this article and to read the other articles on bankruptcy which are available on this website.

What is “bankruptcy”? A basic definition and description

Bankruptcy is a legal process through which a person who is no longer able to pay off their debts – for example, their credit card bills or their medical bills or their vehicle or household appliance loan – files a petition with a court of law requesting that the court issue a judgment declaring the person to be “insolvent.” A person who has been judged to be insolvent becomes largely immune to lawsuits from their creditors – the people or businesses to whom they owe money – over their debts. Ordinarily, the person’s debts are “discharged,” which means that they are no longer required by law to repay them and therefore cannot be held personally liable for any monetary losses that their creditors suffer. In other words, bankruptcy allows an insolvent person to wipe the slate clean and start over.

Needless to say, there are strings attached. Bankruptcies are a remedy of last resort. A person who is judged to be insolvent and discharges their debts through a bankruptcy will have that bankruptcy appear in their credit report for as long as a decade. Also, their creditors will usually acquire a right to any and all of their property that is not subject to an “exemption” under federal or state law. (Examples of the sorts of property that are “exempt” under Arizona law – and therefore will remain the property of the debtor even after they have completed the bankruptcy process – include a person’s ownership interest in their “homestead” (primary residence) up to $150,000, their household furniture, appliances, and personal electronic devices up to $6,000 (or $12,000 combined for a married couple), and one vehicle (up to $6,000, or $12,000 if the debtor or the debtor’s dependent is physically disabled). Most wages, government benefits, and retirement benefits are also exempt. Child support and spousal maintenance, among many other things, are not exempt.)

Chapter 7 bankruptcy

The most common form of bankruptcy available to individual consumers – and the form described above – is a “Chapter 7” bankruptcy. (Chapter 7 refers to the fact that this particular form of bankruptcy is governed by Chapter 7 of the United States Bankruptcy Code.)

A Chapter 7 bankruptcy is a “liquidation” bankruptcy. It is the most basic form of bankruptcy. When a person files for Chapter 7 bankruptcy, all of their non-exempt property is sold – i.e., liquidated – to pay back (or at least partially pay back) their creditors.

Chapter 13 bankruptcy

The other major form of bankruptcy available to individual consumers is a “Chapter 13” bankruptcy.

A Chapter 13 bankruptcy is a “reorganization” bankruptcy. When a person files for Chapter 13 bankruptcy, they are provided with an opportunity to reorganize their finances under the protection of the United States Bankruptcy Court for up to five years.

Whereas a Chapter 7 bankruptcy gives the debtor a chance to start over by discharging their debts and liquidating their non-exempt property in order to (partially) pay back their creditors right away, a Chapter 13 bankruptcy gives the debtor a chance keep all their property, exempt and otherwise, while using their future income to pay back their creditors over a period of time. (In order to file for Chapter 13 bankruptcy, the person must have a steady source of income.)

Never rush into a bankruptcy

Readers who are thinking of filing for bankruptcy are strongly encouraged to consult an attorney to discuss the advantages and disadvantages of the bankruptcy process in general and of Chapter 7 vs. Chapter 13 in particular in the context of your own personal financial situations. Bankruptcy solves certain problems, but it always creates other problems, so filing for bankruptcy is not a decision that should be made hastily or taken lightly.

Sources and further reading

Administrative Office of the United States Courts – Bankruptcy:

Administrative Office of the United States Courts – “Bankruptcy Basics”:

Federal Trade Commission – “Dealing With Debt”:

National Consumer Law Center – “What You Should Know About Bankruptcy”:

United States Bankruptcy Court for the District of Arizona – “Understanding Bankruptcy”:

This website has been prepared for general information purposes only. The information on this website is not legal advice. Legal advice is dependent upon the specific circumstances of each situation. Also, the law may vary from state-to-state or county-to-county, so that some information in this website may not be correct for your situation. Finally, the information contained on this website is not guaranteed to be up to date. Therefore, the information contained in this website cannot replace the advice of competent legal counsel licensed in your jurisdiction.

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