Advantages and Disadvantages Of Bankruptcy

Advantages and Disadvantages Of Bankruptcy

In the event of a financial crisis, there is no guarantee as to what direction things can take. Many people emerge victorious and are able to get back up on their feet. Others, however, are forced to give up their belongings and declare bankruptcy. Whatever knowledge most people have of bankruptcy comes from pop culture. People having to live on the streets, struggling to find food, owning nothing but the clothes already on their bodies. This is not necessarily true. Bankruptcy might sound like something really scary, but it has its own advantages and disadvantages.


Bankruptcy is both a financial condition and a legal process. As a financial condition, it means that someone is not in a position to repay the debts that they owe to others. It is also a legal process through which people or other entities who cannot repay debts may seek relief from some or all of their debts. The bankruptcy process begins with a petition filed by the debtor, which is most common, or on behalf of creditors, which is less common. All of the debtor’s assets are measured and evaluated, and the assets may be used to repay a portion of outstanding debt.

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To understand bankruptcy properly, it is important to know what exempt and non-exempt assets, and secured and unsecured debts are.

Advantages and Disadvantages of Bankruptcy
There are three types of bankruptcy.

Exempt assets cannot be realized to pay the debts. They are personal items, clothing, pensions, tools needed for your employment, vehicle and others. Non-exempt assets can be seized and sold to repay outstanding accounts. Additional property, recreational vehicles, boats, a second car or truck, collectibles or other valuable items, bank accounts, investment accounts, and other items fall under this category.

Secured debts are loans that are given after giving some valuable item as collateral. Non-secured debts are the ones that are not secured by collatoral. For example, credit card debt, medical bills, personal unsecured loans, etc.


In India, there are 3 types of bankruptcy. They are Chapter 7, Chapter 11 and Chapter 13.

‘Chapter 7’ of the Bankruptcy Code is traditional bankruptcy. Under Chapter 7, secured debts are paid off by selling or paying for properties. Non-exempt property is also sold to pay off as much of other debt as possible. Further, all exempt assets are, well, exempted and the debtor is then released from any obligation to repay the remaining dis-chargeable debt.

An important criterion to be able to file bankruptcy under Chapter 7 is the absence of real income to pay off any portion of the debts.

When the debtor has income that can be termed as “sufficient”, bankruptcy has to be filed under Chapter 13. Here, the debt is not entirely paid off. Instead, the payments are restructured by keeping in mind the income. Another option is to get rid of a part of the debt so that the payments for the rest can be managed. These two options can also be complementary. This can be done by spreading payments over a longer period of time or by paying only a part of the loan. During this period, the debtor’s finances are under constant supervision by a legal official.

Under Chapter 11 Bankruptcy, a person or company become a debtor-in-possession. It means that while they continue to have most of their responsibilities for operating the business, they have to additionally work with the trustee for a plan to reorganize their debts. If both the judge and the creditors approve, the plan to do so can be put into action.

Advantages Of Bankruptcy

Stay Against Creditors

An immediate benefit that filing for bankruptcy has for the debtors is that stops all debt collection. The court issues a stay against any and all debt collection activity. After the stay has been granted, if a creditor tries to collect a debt, they can be sued. They can be accused of contempt of court, and be made to pay the debtor damages. This stay covers calls or letters from debt collectors, lawsuits on the debts, wage garnishments, home mortgage foreclosures, and property repossession.

Although it stops creditors from collecting debts, it does not stop all payments. A court-issued stay does not cover criminal proceedings, government tax audits, child support or alimony (establishing, modifying or collecting), et cetera.

The debtor can also apply for an extension on a previously issues stay.

Discharged Debts

Filing for bankruptcy also allows certain debts to be discharged or canceled. This means that the debtor is no longer obliged to repay these debts. A debt that can be eliminated by bankruptcy is known as a dischargeable debt. These usually include unsecured debts such as credit card debt, medical and utility bills, and personal loans.

Continued Ownership

Even after filing for bankruptcy, debtors are allowed to retain ownership of some of their assets. The assets that come under exempt assets, such as residence, first vehicle, etcetera, cannot be seized to repay debts. This is especially important in Chapter 7 and 13 bankruptcies. Some exemptions protect up to a certain value of an asset; sometimes the exemption covers the entire value of an asset.

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Credit Score

Filing bankruptcy can be thought of as cleaning one’s slate. In the situation preceding this filing, the financial condition is extremely bad. Once the factors making the situation bad are removed, the situation, to some extent, automatically improves. Many debtors actually start improving their credit scores after they file for bankruptcy. Once a person’s dischargeable debts are canceled, this allows them to move forward with a clean slate and begin rebuilding their credit. This is because they no longer have to bear the burden of repaying their debts.

Disadvantages Of Bankruptcy

Lingers Around

The biggest disadvantage of filing for bankruptcy is that it stays with you for a really long time. It is shown in the public record file that is accessible by employers, landlords, future creditors, et cetera. This can affect the debtor’s credit score for a really long time. Some experts estimate that declaring bankruptcy lowers the credit score to bottom 20% of files. This stay in the file and affects the debtor’s credit score for upto 10 years.

Non-Dischargeable Debts

There are certain kinds of debt that cannot be discharged by bankruptcy. Non-dischargeable debts typically include alimony and child support, student loans, criminal restitution and fines, and any debts acquired through fraud.

Difficult To Get Loans

The basis for creditors to lend money to someone is their test score. Once it drops because of bankruptcy, the chances of getting loans in the future also reduces. Another disadvantage of this is that it leaves the debtor prone to exploitation. There are lenders who specialize in loaning to people with bad credit. They charge an incredibly high interest rate, The benefit that they get is that the debtor cannot skip out on repaying them because you can’t file a Chapter 7 bankruptcy again for eight years.

Advantages and Disadvantages of Bankruptcy
It is a financial condition and a legal process.

Rise In Insurance Cost

A low credit score also leads to a rise in insurance premium. Insurance companies check a client’s credit report before giving them the insurance, and use low credit score as an excuse to label clients as “high-risk individuals”. Hence, they drive up the insurance premium.

Difficulty in Finding Employment

Most companies check an applicant’s credit score, and a low credit score is usually termed as a red flag.

Pros and Cons of Bankruptcy



Stay against creditors

Lingers around
Discharged debts

Non-dischargeable debts

Continued ownership

Difficult to get loans
Credit score

Rise in insurance cost

Difficulty in finding employment


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Rhythm Bhatia