Alternatives to Bankruptcy

Bankruptcy is a legal proceeding which is the result of the debtor's inability to repay his creditors. Its proceedings are structured to help a debtor settle debts that can be repaid, while money that cannot be requited is forgiven. The debtor can be a business entity, an individual, or a married couple. Although the debtor generally files bankruptcy, the creditor might also initiate proceedings. Sometimes, even governments file bankruptcy in order to settle their debts. On 1st May 2009, the Prime Minister of Zimbabwe admitted that the government was bankrupt. Deteriorating economic conditions have resulted in bankruptcy proceedings becoming a common place phenomenon. In fact, General Motors, a giant in the field of automotive manufacturing, filed for bankruptcy protection on 1st June 2009. It was observed in early April, that nearly 340 British individuals were going bankrupt on a daily basis. This brings us to the issue of whether filing bankruptcy is a good alternative for a debt-laden consumer, corporate, or government.

Filing Bankruptcy - Is it the best way out?

From the economic perspective, bankruptcy results in driving out inefficient firms from business. Depending on the type of business entity, a business can file for it under Chapter 7, Chapter 11 or Chapter 13 of the Bankruptcy Code. Chapter 7 deals with liquidation of assets of the company, while Chapter 13 deals with the repayment of debt under a different set of covenants, and is meant only for sole proprietors and individuals. Chapter 11, on the other hand, results in restructuring a company. Restructuring is an expensive and lengthy process.

People try to resolve their debts by filing bankruptcy. Depending on an individual's financial situation, he can file bankruptcy under either Chapter 7, or Chapter 13 of the Bankruptcy Code. However, this is not an easy way out since it has a negative impact on credit scores, and can result in reducing a person's credit score by as much as 250 points. It will also hamper his ability to seek both, secured and unsecured loans. Moreover, Chapter 7 does not eliminate all debts, whereas Chapter 13 is only meant for a person with regular income. In fact, an individual's Investment Retirement Account can also get affected once he files bankruptcy.

Hence, as far as possible, filing bankruptcy should be avoided and alternatives to the same should be explored by individuals as well as corporations.

Alternatives to Bankruptcy: Personal or Consumer Bankruptcy

The following alternatives can be explored by an individual or by a married couple in order to avoid filing bankruptcy.

Consumer Credit Counseling Services (CCCS): Finding a consumer credit counseling agency should be the first step undertaken by a person considering filing bankruptcy. These non-profit counseling services help people manage their money by providing debt management tips, and by negotiating with creditors as far as debt repayment is concerned. In the US, the National Foundation for Credit Counseling (NFCC) and the Association of Independent Consumer Credit Agencies (AICCA) can be approached for credit counseling advice. In addition to these credit counseling agencies, other non-profit agencies can also be approached. However, one must ensure that the credit counseling agency is legitimate and is affiliated to a national body. The agency should also be accredited by a reputable third party like Council on Accreditation (COA).

Debt Reduction Program: The credit counseling agencies might be willing to negotiate with creditors in order to reduce the amount of debt by as much as 50% .This option is considered, in case a person is unable to meet the minimum payments on the loans. Again, one must ensure that debt management advice is provided by a certified credit counselor. A counselor certified by NFCC would be a good choice, since the consumer is guaranteed a certain level of expertise in the realm of credit counseling.

Consolidating Debts: Debt consolidation can also be considered before filing bankruptcy. The debtor (individual) who is burdened with multiple loans approaches a debt consolidation agency, which negotiates with creditors and tries to bring down the amount of interest charged on different loans. The debt consolidation agency then provides a single loan to the individual/debtor, which acts as a replacement for the multiple loans. The rate of interest on the single loan is generally lower than the interest charged on the multiple loans. One must understand that although debt consolidation results in a person dealing with one creditor instead of many, the person is still stuck with a loan that has to be repaid. Similarly, payday loans consolidation is an option for people struggling with pay day loans.

Borrowing from 401(k): People can usually borrow up to $50,000 from their 401(k) in order to settle mounting debts. Some people might consider it a bad idea to dip into their egg nest in order to pay off loans, since the money invested in 401(k) accumulates tax free. However, it might not be a bad alternative to declaring bankruptcy.

Other Sensible Alternatives: Getting a second job, selling off the car, provided it has some value after depreciation, selling the house and moving into a cheaper apartment, and avoiding the use of credit cards are a few other alternatives that might help.

Alternatives to Corporate Bankruptcy

Corporates too should explore various alternatives to bankruptcy.

Commercial Debt Counseling: A business can avail of commercial debt counseling for advice on debt management. These counseling services can help the business settle issues with creditors without legal intervention. Approaching these counseling services will not have a negative impact on the credit rating of the business. Moreover, commercial debt counselors provide an objective evaluation of the business, without it having to entail any further financial obligations.

Restructuring vs Liquidating: Many business firms are going bankrupt due to recession. The companies have a choice between opting for termination or reorganization. Companies that file for Chapter 7 cease to exist, since assets of the company are liquidated in order to pay the creditors. Chapter 11 is meant for corporations and partnerships, and results in restructuring of the company. In this case, the business continues to operate, and in due course of time creditors recover their money. In case of a sole proprietorship, filing under Chapter 13 can help the proprietor pay off debts. However, the debts have to be paid off in 3 to 5 years time. History has shown that corporations that have filed bankruptcy under chapter 11 have successfully recovered following a period of restructuring. A large company has a better chance of surviving as compared to a small company since restructuring is a very costly process.

Although bankruptcy is a difficult situation, it is clear that people can avoid filing bankruptcy by adopting various measures. Companies too, have various debt management options, failing which they can go in for complete restructuring that would be overseen by the court, rather than opting for liquidation of assets. Prudence demands that individuals and corporates should explore various alternatives since filing bankruptcy is not meant to be the easy way out for a debtor.