Business, Legal & Accounting Glossary

Definition: Bankruptcy


Quick Summary of Bankruptcy

A legal proceeding that relieves you of the responsibility of paying your debts or provides you with protection while attempting to repay your debts. There are two types of bankruptcies — liquidation, in which your debts are wiped out (discharged) and reorganization, in which you provide the court with a plan for how you intend to repay your debts.

Video Guide For Bankruptcy

What is the dictionary definition of Bankruptcy?

Dictionary Definition

A legally declared or recognized condition of insolvency of a person or organization.

Bankruptcy refers to the filing of a petition with the US Bankruptcy Court by a company or an individual to declare that such company or individual is unable to repay its debt obligations. Bankruptcy rights and obligations are outlined in Title 11 of the United States Code (i.e. the Bankruptcy Code) and is amended from time to time.

In the majority of cases, bankruptcy is voluntary and filed by the debtor.

In less common cases of involuntary bankruptcy, it is the creditor that initiates the bankruptcy to collect what is owed. Bankruptcy can be declared under various chapters of the US Bankruptcy Code but most bankruptcies are filed under Chapter 7, Chapter 11, or Chapter 13. In a Chapter 11 bankruptcy, typically reserve for companies but also for individuals with a lot of assets, the bankrupt company will outline a reorganization plan and show how it plans on repaying its creditors while remaining in business. In a Chapter 13 bankruptcy, the debtor, typically an individual with a steady income, will outline a repayment plan with a timeline which will allow such debtor to keep his assets while repaying its debt based on expected future earnings. Unlike with a Chapter 11 bankruptcy or a Chapter 13 bankruptcy where the debtor can keep his assets, a Chapter 7 bankruptcy requires liquidation of a debtor assets for distribution to creditors.

As authorized by the Article 1, Section 8, Clause 4 of the Constitution, Congress has enacted several amendments to the US Bankruptcy Code over the years. The two major amendments in recent decades were the US Bankruptcy Reform Act of 1978 and most recently the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 which, among other things, establishes tighter requirements to file a Chapter 7 or Chapter 11 bankruptcy.

Full Definition of Bankruptcy

Bankruptcy is a legally declared inability or impairment of ability of an individual or organization to pay their creditors. A declared state of bankruptcy can be requested or initiated by the bankrupt individual or organisation, or it can be requested by creditors in an effort to recoup a portion of what they are owed. However, in the overwhelming majority of cases, the bankruptcy is initiated by the “bankrupt” individual or organization.

The primary purpose of the laws of bankruptcy are:

  1. to give an honest debtor a “fresh start” in life by relieving the debtor of most debts, and
  2. to repay creditors in an orderly manner to the extent that the debtor has property available for payment.

Bankruptcy allows the debtor to resolve his debts through the division of his assets among his creditors. Additionally, the declaration of bankruptcy allows debtors to be discharged of most of the financial obligations after their assets are distributed, even if their debts have not been paid in full. During the pendency of a bankruptcy proceeding, the “Debtor” is protected from extra-Bankruptcy action by creditors by a legally imposed “stay.”

In the United Kingdom (UK), a Trustee in bankruptcy must be either an Official Receiver (a civil servant) or a licensed insolvency practitioner.

Following the introduction of the Enterprise Act, a UK bankruptcy will now normally last no longer than 12 months and maybe less, if the Official Receiver files in court a certificate that his investigations are complete.

It is expected that the UK Government’s liberalisation of the UK bankruptcy regime will massively increase the number of bankruptcy cases; initial Government statistics appear to bear this out. It remains to be seen whether the leash has been loosened too far and whether the legislation will need reviewing if the system becomes too overheated with debt-dumping debtors.

Bankruptcy Types

Bankruptcy is primarily of two types: voluntary bankruptcy and involuntary bankruptcy. Bankruptcy proceedings initiated by the debtor is termed voluntary bankruptcy. Bankruptcy cases initiated by creditors are known as involuntary bankruptcy. A bankruptcy order can be initiated without the consent of the debtor. A dispute between debtor and creditor over monetary claims can be settled before the petition is to be heard in a legal court.

Financial Limits

Bankruptcy involves the following actions:

  • The debtor cannot officially receive credit beyond a certain predetermined limit
  • Debtor(s) suffer a loss of control over its assets
  • The debtor cannot function as a company director.
  • Trading in other businesses by the debtor is prohibited until all persons concerned with the matter are informed.
  • The debtor cannot become a member of parliament
  • The debtor can be examined publicly in a courtroom.
  • Credit is affected for a considerable period of time

Relative Advantages

There are certain advantages for a company or an individual to declare bankruptcy. The event allows the debtor a possible discharge in a year’s time. A new life is possible after that. Creditors may also use bankruptcy proceedings to conduct a thorough investigation into the debtor’s business.

Prepackaged Bankruptcy

It is a plan for financial refurbishment that a company fixes in conjunction with its creditors. The plan takes effect after the company becomes bankrupt. It is compulsory to obtain the consent of shareholders before a prepackaged bankruptcy is created and applied.

The concept behind prepackaged bankruptcy is to simplify the whole process. An effective package assists the business entity to save accounting and legal costs. A quicker recovery would help a company yield greater profits and create revenue from core activities.

Bankruptcy In The United States

Bankruptcy is federal statutory law (Title 11 of the United States Code) based upon the Constitutional requirement for “uniform laws on the subject of Bankruptcy throughout the United States.” (Article I, Section 8). Bankruptcy proceedings are undertaken in the United States Bankruptcy Courts, part of the District Court system.

There are several types of proceedings that fit under the general category bankruptcy. The US Bankruptcy Code has multiple chapters, each describing a different procedure available for debt resolution. Liquidation under a Chapter 7 filing is the most common form of bankruptcy. Liquidation involves the appointment of a trustee who collects the non-exempt property of the debtor, sells it and distributes the proceeds to the creditors. Bankruptcy under Chapter 11, Chapter 12, or Chapter 13 is more complex and involves allowing the debtor to use future earnings to pay off creditors. In addition, there is Chapter 9 bankruptcy, available only to municipalities; perhaps the most famous example of a municipal bankruptcy was in Orange County, California. Chapter 9 is a form of reorganization, not liquidation. Chapter 12 is somewhat like Chapter 13 but is only available to farmers in certain situations. As recently as mid-2004 Chapter 12 was scheduled to expire but in late 2004 it was given a renewed lease on life.

Bankruptcy can be entered into voluntarily by the debtor. It can also be commenced involuntarily by as few as one creditor if the debt owed is large enough. An involuntary bankruptcy may be used as a collection tool but its use can be very risky and, if wielded improperly, may subject the creditor to large damages.

Some property is exempt from being sold to pay debts in a bankruptcy. The law varies greatly from state to state. In some states, exempt property includes equity in a home or car, tools of the trade, and some amount of personal effects. In other states, an asset class such as tools of the trade will not be exempt by virtue of its class except to the extent it is claimed under a more general exemption for personal property.

One major purpose of bankruptcy is to ensure orderly and reasonable management of debt. Thus, exemptions for personal effects are thought to prevent punitive seizures of personal items of little or no economic value (diary, toothbrush, ordinary clothing), since this does not promote any desirable economic result. Similarly, tools of the trade may depend on the available exemptions, be a permitted exemption as their continued possession allows the insolvent debtor to move forward into productive work as soon as possible.

Not every debt may be discharged under every chapter of the Code. Certain taxes owed to Federal, state or local government, government-guaranteed student loans, and support obligations are not dischargeable (but nb., guaranteed student loans are potentially dischargeable should the debtor prevail in a difficult-to-win adversary proceeding brought in the nature of a complaint to determine dischargeability that’s brought against the lender; also, the debtor can petition the court for a “financial hardship” discharge, but it is very rare that such a discharge is granted). The debtor’s liability on a Secured debt, such as a mortgage or mechanics lien on a home, maybe discharged, but the effects of the mortgage or mechanics lien cannot be discharged in most cases if it affixed prior to filing, so if the debtor wishes to retain the property, the debt must usually be paid for as agreed. (See also lien avoidance, reaffirmation agreement)(Note: there may be additional flexibility available in Chapter 13 for debtors dealing with over secured collateral such as a financed auto, so long as the over secured property is not the debtor’s primary residence.)

Also, any debt tainted by one of a variety of wrongful acts recognized by the Bankruptcy Code, including defalcation, or consumer purchases or cash advances above a certain amount incurred a short time before filing, cannot be discharged. However, certain kinds of debt, such as debts incurred by way of fraud, maybe dischargeable through a Chapter 13 super discharge. All in all, as of 2005, there are 19 general categories of debt that cannot be discharged in a Chapter 7 bankruptcy, and fewer debts that cannot be discharged under Chapter 13.

Bankruptcy Abuse Prevention & Consumer Protection Act of 2005

The United States Congress is considering (in 2005) legislation that would vastly change the laws of bankruptcy as they pertain to individuals. Some of the more significant (and controversial) changes include:

Making it more difficult for individuals to receive a Chapter 7 discharge. A means test is to be imposed on would-be filers, one that is linked to whether the debtor’s earnings in the six-month period prior to filing were above or below the median income for the debtor’s state of residence.

Making Chapter 13 far less attractive by, amongst other things, eliminating its “super discharge,” eliminating the ability of debtors to “cram down” non-residential secured property (i.e., to disallow them from paying off the real value of the secured property as secured while treating the excess value as unsecured, by disallowing the reduction of interest charged on the debt to reasonable values), by removing the credit for payments on retained secured property from the calculation of disposable income, and by requiring that debtors undergo counselling in order to file under Chapter 13.

Requiring that debtor counsel conducts an investigation of their clients’ filings and be personally liable for them, a duty apparently unprecedented under U.S. law. A similar requirement will likely force debtors desiring to reaffirm to attend a court hearing and prove to the court that they can meet obligations they wish to reaffirm (because few debtor’s attorneys will wish to certify their belief of their client’s prospective ability to pay on a reaffirmed debt). Those who cannot thus prove will be compelled to surrender the property.
Limiting the homestead protection to $125,000 in equity and establishing a 40 month residency period before such protections are recognized in Bankruptcy.
The legislation is supported by President George W. Bush and opposed by Democrats. This legislation was originated during the Clinton Administration and had more bipartisan support at the time. But the bill has languished for years due to disagreements in Congress as to the level of the means test, and whether anti-abortion groups can use bankruptcy to discharge fines levied to them by courts for actions that resulted in property damage or injury such as bombing abortion clinics.

Bankruptcy Fraud

Bankruptcy fraud is a federal crime. Its provisions are found at Title 18 of the United States Code. Bankruptcy fraud is prosecuted by the United States Attorney, typically after a reference from the United States Trustee, the Interim Trustee, or a bankruptcy judge.

When bankruptcy is filed with criminal intent, as bankruptcy fraud, a business crime, the debtor may be subject to a felony prosecution in federal court. This should be distinguished from strategic bankruptcy, which is not a criminal act. Common types of bankruptcy fraud include petition mills, false oath, concealment of assets, fraudulent conveyance, etc. Multiple filings are not per se fraudulent; as with all things in the law, it depends on the circumstances.

Bankruptcy fraud can also sometimes lead to criminal prosecution in state courts, under the charge of theft of the goods or services obtained by the debtor for which payment, in whole or in part, was evaded by the fraudulent bankruptcy filing.

Bankruptcy FAQ's

How Can Bankruptcy Help Me?

Because of high-interest credit cards, unexpected life events, a reduction in income, or high medical bills, many people struggle with the burden of overwhelming debt. By filing for bankruptcy, you can eliminate debts or create a bankruptcy court payment plan that protects you from creditors, lawsuits, and judgments. While there are different types of bankruptcy, they are all designed to give you a fresh start and overcome the burden of debilitating debt.

Am I Eligible to File Bankruptcy?

Nearly all people and businesses are eligible to file for bankruptcy. Each bankruptcy petition is evaluated by the bankruptcy court and bankruptcy trustee to determine the exact procedure, and each case can vary. The vast majority of debts can be discharged in bankruptcy, but there are a few exceptions such as certain taxes, student loans and court-ordered restitution. In most cases, common debt such as credit cards, medical bills, even judgments, can be easily discharged in bankruptcy.

What Types of Bankruptcy Can an Individual File?

Throughout California, particularly in the Central District, most debtors file a Chapter 7 bankruptcy, although Chapter 13 and Chapter 11 are sometimes options as well. Each of these has their own guidelines and procedures:

Chapter 7 – In the vast majority of Chapter 7 cases, all debts are discharged and the debtor retains all property through the use of “exemptions.” Exemptions protect a house, cars, household items, even retirement accounts.
Chapter 13 – In Chapter 13, you create a plan to repay creditors over 5 years, supervised by the court, which will pay back all or a designated portion of your debts. The repayment amount in Chapter 13 is determined by the debtors ability to pay, no particular percentage is required.

What Types of Bankruptcy Can a Business File?

Businesses are permitted to file for Chapter 7 or Chapter 11 bankruptcy, but not Chapter 13. Business people often make strategic choices as to which chapter to file depending on whether they intend to continue ongoing business operations, and what sort of business assets can be liquidated.

Chapter 7 – Many corporations cease operations going into a Chapter 7, but it is often possible to continue operations of many service-type businesses at the discretion of the bankruptcy trustee, so long as all appropriate insurance is in place. In some instances, business assets are sold, with the proceeds used to pay creditors. Sometimes, an entire business may be sold intact to other companies through liquidation. Businesses do not get exemptions in bankruptcy however.
Chapter 11 – Most often, the debtor/business owner will remain in control of the company. However, he or she will be subjected to oversight and jurisdiction by the bankruptcy court. In order to eliminate debt, the company can be reorganized and creditors can be given first priority on earnings in order to pay off debt. Additionally, contracts may be cancelled and litigation against the company or owner can be ended through an automatic stay.
Understanding these differences and what plan is right for the wellbeing of your company will help you make the right choice and prevent unnecessary complications and difficulties.

What is Exempt?

Bankruptcy rarely, but sometimes, includes the court taking and selling property in order to pay off debts in a process called liquidation. However, most types of property are exempt from being liquidated under California law, which includes:

Equity in a home (up to a certain amount depending on age and marital status);
Ordinary and necessary household furnishings, clothing, and appliances;
Tools used for business or trade;
Certain equity in all vehicles;
75 percent of all paid earnings;
Cash value of insurance policies;
Retirement plans;
Social Security, welfare, unemployment, and other public benefits
Exemptions can be tricky and confusing, it is very difficult to make blanket statements about exemptions as each case and each debtor is different. In most cases however, all or nearly all property is exempt and the debtor retains all their property after bankruptcy, this is referred to a “no-asset” case and is the most common scenario in California bankruptcy cases.

Who is a Trustee in a Bankruptcy Case?

A trustee is an individual who may or may not be an attorney, appointed by the U.S. Department of Justice in a bankruptcy case to oversee and administer a bankruptcy estate. The trustee is in charge of making sure that the requirements imposed by the court are carried out. This includes verifying a debtor’s identification, reviewing bankruptcy schedules for accuracy, and in rare cases, liquidating assets.

Your bankruptcy trustee is identified on your Notice of Bankruptcy, Meeting of Creditors and Deadlines. The name of your trustee can also be found in the public terminals in divisional offices, through the Multi-Court Voice Case Information System, or by calling the divisional office that handles your bankruptcy case.

How Long Will My Bankruptcy Case Take?

Not all bankruptcy cases are the same and the different factors that go into processing your case and determining how your debts will be handled will impact the amount of time it takes to close a case. Chapter 7 cases typically take between 3 and 6 months to complete. Since Chapter 13 cases involve payment plans, they typically last between 3 and 5 years, during which time the debtor will pay creditors without interest.

Cite Term

To help you cite our definitions in your bibliography, here is the proper citation layout for the three major formatting styles, with all of the relevant information filled in.

Page URL
Modern Language Association (MLA):
Bankruptcy. Payroll & Accounting Heaven Ltd.
May 28, 2023
Chicago Manual of Style (CMS):
Bankruptcy. Payroll & Accounting Heaven Ltd. (accessed: May 28, 2023).
American Psychological Association (APA):
Bankruptcy. Retrieved May 28, 2023
, from website:

Definition Sources

Definitions for Bankruptcy are sourced/syndicated and enhanced from:

  • A Dictionary of Economics (Oxford Quick Reference)
  • Oxford Dictionary Of Accounting
  • Oxford Dictionary Of Business & Management

This glossary post was last updated: 22nd November, 2021 | 0 Views.