Business Glossary

state of insolvency of an individual or an organization-in other words, an inability to pay debts. There are two kinds of legal bankruptcy under U.S. law: involuntary, when one or more creditors petition to have a debtor judged insolvent by a court; and voluntary, when the debtor brings the petition. In both cases, the objective is an orderly and equitable settlement of obligations.

The 1978 Bankruptcy Reform Act removed some of the rigidities of the old law and permitted more flexibility in procedures. The Bankruptcy Reform Act of 1984 curtailed some of the more liberal provisions (mainly affecting consumer bankruptcy) of the 1978 act.

Chapter 7 of the 1978 act, dealing with liquidation , provides for a court-appointed interim trustee with broad powers and discretion to make management changes, arrange unsecured financing, and generally operate the debtor business in such a way as to prevent loss. Only by filing an appropriate bond is the debtor able to regain possession from the trustee.

Chapter 11, which deals with reorganization of businesses, provides that, unless the court rules otherwise, the debtor remains in possession of the business and in control of its operation. Debtor and creditors are allowed considerable flexibility in working together.

Chapter 13, which deals with debt adjustment or reorganization for individuals, allows people to put forward a plan to repay creditors over time, usually from future income. Most consumer reorganizations take place under Chapter 13 of the bankruptcy law. A Chapter 13 bankruptcy normally requires monthly payments to the bankruptcy trustee for a period of three to five years. Once payments have been completed under the plan, the debtors are entitled to a discharge. Chapter 13 reorganizations also allow debtors to keep more property than in a Chapter 7 liquidation.

the state of insolvency or inability to pay debts.

Bankruptcy courts deal with two broad types of cases: voluntary bankruptcy by debtors seeking a fresh start, and involuntary bankruptcy filed by a sufficient number of creditors, who believe the debtor has committed an act of bankruptcy by concealing assets or favoring one creditor over another. In both cases, the objective is a fair and equitable settlement of claims and distribution of assets. Filing a petition initiates an automatic stay against further debt collection until a debt is discharged, the petition is dismissed, or a repayment plan is accepted by creditors. Once a petition is filed, the bankruptcy remains on a debtor's credit bureau report for a 10-year period.

The Bankruptcy Reform Act of 1978, the first major revision in the bankruptcy code in four decades, brought about several important changes: the new code simplified the procedures for filing petitions, modified the absolute priority rule giving secured creditors seniority over other creditors, limited creditor rights to set-off clause claims against a debtor's assets, and expanded the powers of federal bankruptcy judges to decide cases. Amendments to the code in 1984 gave bankruptcy courts the power to dismiss so-called abusive petitions by debtors concealing assets. Amendments enacted in 2005 (the Bankruptcy Abuse Prevention and Consumer Protection Act) further modified the bankruptcy code to prevent abusive petitions. Individuals who have sufficient income to repay some of their debts (as determined by a "means test") must instead file a Chapter 13 bankruptcy petition.

The important chapters in the revised code are the following:

Chapter 7: called a liquidation , allows a court-appointed trustee with broad discretionary powers to distribute assets among creditors and arrange interim financing. In general, the trustee represents the interests of the unsecured creditors, or general creditors. If, however, there are no assets, the debt is discharged, and the creditors receive nothing.

Chapter 9: a rarely used section of the code, designed for adjustment of debts of a municipality. Also called a municipal reorganization.

Chapter 11: a reorganization , normally by a business, allowing the debtor (called a debtor in possession if no trustee is named) to maintain operating control, while restructuring debts and working out a repayment schedule acceptable to creditors. Creditor loans to Chapter 11 debtors are permitted under certain conditions.

Chapter 12: a new provision dealing with agricultural bankruptcies, allows small family-owned farms with debts under $1.5 million to repay obligations based on fair market value of the loan collateral.

Chapter 13: a debt repayment plan, called a wage earner plan , filed by individuals earning regular income. The debtor files a budget with the court, and agrees to make partial payment (less than 100%) of obligations owed to creditors over a three- to five-year period, normally within three years.

See also redemption , composition , cramdown (1) , voidable preference , discharge of bankruptcy , preference , priority of lien , reaffirmation

state of insolvency of an individual or an organization, that is, an inability to pay debts. There are two kinds of legal bankruptcy under U.S. law: Chapter 7 or involuntary, when one or more creditors petition to have a debtor judged insolvent by a court; and Chapter 11, or voluntary, when the debtor brings the petition. In both cases the objective is an orderly and equitable settlement of obligations.

See also chapter 11 of the 1978 bankruptcy act , chapter 7 of the 1978 bankruptcy act

the financial inability to pay one's debts when due. The debtor seeks relief through court action that may work out or erase debts.

Example: Carter lost his job but continued to live extravagantly on credit . When accounts were overdue, Carter filed a bankruptcy petition. The court allowed him to pay creditors 10 cents per dollar of debt, payable over 3 years.