Personal bankruptcy options: liquidation vs. reorganization

When financial difficulties turn from bad to worse and people fear they may never be able to catch up on their overdue bills, many turn to bankruptcy as a way to make a fresh financial start. While most people have heard of bankruptcy, many are unaware of how the process works and how it can benefit people who are struggling with unmanageable debt.

What Is bankruptcy?

Bankruptcy is a legal procedure that helps people get out of debt and repay their creditors. Depending on their circumstances, individuals who file for bankruptcy typically use one of two types: Chapter 7 bankruptcy, which is often called liquidation, or Chapter 13 bankruptcy, which is also referred to as reorganization.

Chapter 7 "Liquidation" Bankruptcy

During Chapter 7 bankruptcy, most of a person's debts are discharged and creditors are generally barred from seeking payment. Depending on the circumstances, however, it may be necessary to surrender certain kinds of property in exchange for debt forgiveness. Assets such as a vacation home, second vehicle or valuable antiques may be sold and the proceeds used to pay off a portion of the person's debts.

However, it is important to keep in mind that liquidating assets is not always necessary in order to obtain debt relief through Chapter 7 bankruptcy. In fact, many people who file for Chapter 7 bankruptcy are able to liquidate only a few assets or none at all. This is because the bankruptcy laws specify that several types of property are exempt from liquidation. For instance, a person's primary vehicle, household items and a portion of his or her home equity are typically exempt from liquidation.

Chapter 13 "Reorganization" Bankruptcy

Chapter 13 bankruptcy is different from Chapter 7 bankruptcy in a few key respects. First, it is typically not necessary to liquidate assets during Chapter 13 bankruptcy - even those that are not considered exempt. For people with substantial assets, such as investment accounts or a second home, this may make Chapter 13 a more appealing option than Chapter 7 since it will allow them to keep their property.

Another major distinction between the two types of bankruptcy is that Chapter 13 does not result in the immediate discharge of debt. Instead, a person who files for Chapter 13 bankruptcy will have his or her debts restructured under a court-approved repayment plan and will be required to make payments on the plan for a period of three or five years. Under the plan, certain types of debt - such as past due child support and delinquent taxes - are considered high priority and are paid off ahead of other debts. If the individual successfully completes the payment plan, certain remaining debts may be discharged at the end of the repayment period.

Seek Legal Advice When Considering Bankruptcy

As outlined above, there are potential benefits and drawbacks to both types of consumer bankruptcy. While this article provides an introduction to some of the things to consider when weighing bankruptcy as an option for getting out of debt, it is important to discuss your situation with a knowledgeable bankruptcy attorney who can advise you of your options and help you plan the best course of action for your specific circumstances.