What Drives an Individual or Business to File for Bankruptcy?
When a consumer or business finds themselves buried in debt, with little or no chance of being able to dig themselves out for a long period of time, sometimes declaring bankruptcy is the right option. There are federal laws set in place that can give debt relief to businesses and individuals, so they can make a fresh financial start. It’s not an easy decision to make and has a variety of advantages and disadvantages.
Four common types of bankruptcy:
Chapter 7 Bankruptcy
The debtor may be an individual, a partnership, a corporation, or other business entity. Under this chapter the bankruptcy trustee liquidates all the debtor’s nonexempt assets to repay creditors. This may be a good option for someone with little to no income and a lot of outstanding unsecured debt. A business cannot stay operational after filing under chapter 7.
Chapter 11 Bankruptcy
Frequently used by corporations, sole proprietors, or partnerships, it gives them a chance to reorganize their business, stay in control of assets, and negotiate a payment plan with creditors for less than the original debt owed. All parties must agree upon the repayment plan; this may be the best option for a business that wishes to continue operating.
Chapter 12 Bankruptcy
A relatively new bankruptcy law and is designed for family farmers or fishermen who have a consistent annual income. It allows them a chance to repay all or part of their debts over time. Chapter 12 was created due to the economic realities faced by many family farmers/fisherman, it is less complicated and less expensive than Chapter 11 & 13.
Chapter 13 Bankruptcy
This is an option individuals or sole proprietors who do not want to liquidate their assets, have a source of regular income, and need time to catch up on debts. Debtors and creditors will negotiate a repayment plan over the course of 3 to 5 years. Under this chapter individuals can save their homes from foreclosure and consolidate debts to be paid to the trustee who then distributes to creditors.
When you file for bankruptcy, collection agencies and creditors will be prohibited from trying to collect debt from you. Randall Saxton of Saxton Law, PLLC told us, “This is called the automatic stay and goes into effect immediately upon filing the bankruptcy case for the duration of the case without the need for a court order.” In most cases, they will no longer be able to call, send letters, file lawsuits, garnish wages, or seize any assets. In cases of a ‘successful’ bankruptcy, the court will discharge certain debts that you will no longer be held accountable for.
Filing for bankruptcy is a scary and confusing decision for most individuals and businesses, it can become even scarier in the rare cases when debts are not discharged, and you are ordered to release nonexempt assets for auction or sale. If done incorrectly or for the wrong reasons, declaring bankruptcy can end up being a very expensive process.
If you’re planning to declare bankruptcy, be prepared for it to have a significant impact on your credit.
Now if you are considering bankruptcy, chances are your credit is already a mess due to the outstanding debt. But, nevertheless, it’s important to know what to expect:
- Bankruptcies can remain on credit for up to 10 years depending on the Chapter.
- Chapters 7 & 11 remain on credit for 10 years, regardless of whether it was discharged or dismissed.
- Chapters 12 & 13 remain on file for 10 years from the date filed but, if discharged, will remain on file for 7 years from the date filed.
- Bankruptcy has the power to drop your score by over two hundred points or as little as 50 points…Why such a difference? Let’s see, if your credit score is in the 700’s and you declare Bankruptcy, be prepared for the score to drop much more than an individual who had a credit score in the 400’s prior to bankruptcy. FICO mortgage credit scores reflect the risk of a borrower, if the borrower is already a very high risk prior to bankruptcy, they do not have much room to drop after declaring. This in turn will impact your access to new credit, loans, leases, and the pricing associated with them. For some in certain finance industries it can impact employment opportunities.
Rebuilding your credit after filing can be a long road but depending on your situation it can be shorter than trying to pay the debt back and avoiding a bankruptcy. For many, with our help, they can have good scores within 3-4 years after the Bankruptcy. Bankruptcy gives many a chance to learn from the past financial mistakes and gain a fresh start.
The impact that bankruptcy can have on your business credit will vary
How bankruptcy hits your credit depends on what type of bankruptcy you go into and the structure of your business. Chapter 11 is commonly used by businesses with many assets since it gives your business a chance to maintain control of assets and still operate while reorganizing and restructuring.
- Bankruptcies are listed on public record and can stay on business credit reports for up to 20 years.
- Due to the unregulated nature of business credit, a bankruptcy will impact all three business credit profiles in a variety of ways.
- A bankruptcy will raise your risk potential of ceasing operations without paying back creditors.
- If your business was able to reorganize and prioritize debt during bankruptcy, you should now be able to handle your bills. All bills should be paid on time; you are now in a place where rebuilding business credit profiles should be a top priority.
- After you file, you should be monitoring all three business credit profiles. (Also, the principal’s personal credit profiles depending on business structure).
If you have a bankruptcy on file for your business you should be consulting with a credit expert, since a bankruptcy can impact businesses in such a wide variety of ways, the only way to know where it is hitting your business credit is by analyzing each report.