Pros and Cons of Bankruptcy

Bankruptcy refers to a legal acknowledgement of insolvency of an individual, or an organization. The jurisdiction of such cases lies under special bankruptcy courts. The procedure, criteria, as well as the terms and conditions, differ from one state to another, and depend on various factors. It serves as a way out for situations where neither the outstanding debt obligations can be fulfilled, nor an agreement can be negotiated with the creditors. However, one must consider the "costs" associated as well.

Types
Depending on the insolvent entity, bankruptcy is classified as individual/personal and business/corporate bankruptcy. As the name suggests, when an individual files for bankruptcy, it is termed as individual/personal bankruptcy. On the other hand, business organizations can seek protection under business/corporate bankruptcy.

The US Bankruptcy Code defines six different types of bankruptcies named after the Chapters under which they have been described. These are Chapter 7 (Liquidation), Chapter 9 (Adjustment of Debts of a Municipality), Chapter 11 (Reorganization), Chapter 12 (Adjustment of Debts of a Family Farmer or Fisherman), Chapter 13 (Adjustment of Debts of an Individual with Regular Income) and Chapter 15 (Ancillary and Other Cross-Border Cases). Each chapter defines the eligibility criteria, and the legal proceedings to be followed. Let us have a look at the pros and cons of individual and corporate bankruptcies.

Pros
Under certain circumstances bankruptcy is the best way to deal with financial crisis and insolvency issues. Some of the benefits are as follows:

Stay on Debt Recovery Actions
The creditors are assured that their dues will be cleared and their interests are safeguarded. As a consequence of this assurance, as well as the orders from bankruptcy court, new recovery actions against the debtor cannot be initiated (with certain exceptions). The creditor lawsuits, if any, are blocked.

Debt Discharge
The court can order to cancel some of the debt obligations. Once a debt is discharged or canceled, unsecured creditors are unable to initiate any kind of recovery action for that particular debt. Once the proceedings are over, the debt slate is clean, and the debtor can newly commence with activities to earn a living.

Property Protection

• Individuals have the option to secure some of their assets; namely a motor vehicle, household goods and furnishings, jewelry (worth a specific amount), a part of equity in the house, etc., from being liquidated and used as means for debt repayment. For debtors who have obtained unsecured loans, such exemption will prevent creditors from claiming rights on all the assets of the debtor. Individuals can avoid foreclosures, and figure out alternative means for repayment. Family farmers seeking Chapter 12 bankruptcy can retain ownership and control of their farms.
• Corporates - for which long-term cash flows/revenues are expected - benefit from Chapter 11 by getting a chance to retain their business, reorganize their debt payment structure, and gain extensions for repayment of dues. Thus, their business need not be wound up for paying debts. Proprietors can seek protection of their personal assets, in case their business venture fails, and has to be wound up.

Tax Benefits

• The Bankruptcy court issues orders for a stay on any litigation pertaining to tax payments, against the individual or the organization.
• Under normal circumstances, if a debt is discharged or canceled, the canceled amount is considered as a taxable income creating a tax liability. But, the debt amount discharged under bankruptcy proceedings is tax-free.
• Corporates enjoy the option of tax-free reorganizations allowed under Chapter 11. Certain asset transfer transactions are exempted from taxes by the Internal Revenue Service (IRS).

Cons
Bankruptcy is a major negative event that an individual may experience during his/her lifetime. In fact, it is a life-changing event with long-lasting consequences. The other downsides are described below:

Credibility
The credibility of the debtor is affected, since the state of insolvency is disclosed publicly via newspaper notices. As per the Fair Credit Reporting Act, the credit history of a debtor will reflect his bankruptcy record for 7-10 long years (depending on the type of chapter). This may create hurdles in obtaining future credit. A debtor may even be discriminated against, on several instances, and securing a job or obtaining insurance might become a difficult task.

Property Liquidation
The nonexempt property and/or a part of the cash obtained on liquidation is lost in the repayment process defined under Chapter 7.

Bankruptcy Costs
The court charges, inclusive of the administrative fees, add up to more than $300. In addition to this, expenses incurred for financial counseling and appointment of trustee (if required) are huge.

Tax Disadvantages
The debtor can choose to have a short tax year, ending on the filing date, and begin a new one thereon. However, the tax payments due, up to the filing date, are non-dischargeable, and entitles IRS to have a priority claim on the bankruptcy estate. This estate will remain free of tax claims, if the debtor does not opt to end his tax year. However, the tax debts will not be discharged.

A proper understanding of the short-term and long-term prospects, combined with professional credit counseling will enable you to take an informed decision as far as filing for bankruptcy is concerned. An experienced bankruptcy lawyer is the best person to consult and seek advice regarding the eligibility, process, payments, and the rules and regulations applicable.