Individuals can file for bankruptcy in a federal court under Chapter 7 (“straight bankruptcy”) or Chapter 13 (a wage earner repayment plan).

In a Chapter 7 bankruptcy, the individual is allowed to keep certain exempt property, and most liens, such as real estate mortgages, survive. Other assets, if any, are sold (liquidated) by the interim trustee to repay creditors. Many types of unsecured debt are cancelled. There are general classes of debt not discharged in a Chapter 7.

Common exceptions to discharge include child support, most taxes, most student loans (unless the debtor prevails in a difficult-to-win adversary proceeding brought to determinate the dischargeability of the student loan), fraud or misrepresentation in obtaining credit, and fines and restitution imposed by a court for any crimes committed by the debtor.

Consumer credit and creditworthiness is a complex subject, however. Future ability to obtain credit is dependent on multiple factors including income and post-bankruptcy obligations.

Another aspect to consider is whether or not the debtor can avoid a challenge by the United States Trustee to his or her Chapter 7 filing as abusive. One aspect of whether the U.S. Trustee can prevail in a challenge to the debtor’s Chapter 7 filing is whether or not he can otherwise afford to repay some or all of his debts out of disposable income in the three year time frame provided by Chapter 13. If so, then the U.S. Trustee may succeed in preventing the debtor from receiving a discharge under Chapter 7, effectively forcing the debtor into Chapter 13.

Creditworthiness and the likelihood of receiving a Chapter 7 discharge are only a few many issues to be considered in determining whether to file bankruptcy. The importance of the effects of bankruptcy on creditworthiness is sometimes overemphasized because by the time most debtors are ready to file for bankruptcy their credit score is already ruined.

One of the immediate benefits of filing for bankruptcy is an “automatic stay”, which stops any lawsuit filed against you and most actions against your property by a creditor, collection agency, or government entity. It is designed to prevent amongst other things: utility disconnections, foreclosures/evictions, and multiple wage garnishments.

When a troubled business is badly in debt and unable to service that debt or pay its creditors, it may file (or be forced by its creditors to file) for bankruptcy in a federal court under Chapter 7 (liquidation) or Chapter 11 (reorganization).

A Chapter 7 filing means that the business intends to sell all its assets, distribute the proceeds to its creditors, and then cease operations.

This may or may not mean that all employees will lose their jobs; when a very large company enters Chapter 7 bankruptcy, it may be that entire divisions of the company are sold intact to other companies during the liquidation.

Secured creditors, such as bondholders, have a higher-priority claim on the proceeds than unsecured creditors, such as vendors who have not yet been paid for products they previously delivered to the company.

A corporation or other legal entity that is a debtor under Chapter 7 is not entitled to a discharge of its debts: once all assets of the company have been fully administered, the case is closed and the debts of the entity, theoretically, continue to exist.