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What is Bankruptcy and the Importance of the Bankruptcy System?

by Megan Roth5 min read
What is bankruptcy and The Importance of The Bankruptcy System?

The word “bankruptcy” conjures up images of losing everything – your home, your assets, your life. While bankruptcy is a traumatic life event, it isn’t as bad as that. So the question becomes, what is bankruptcy?


What is bankruptcy?

Bankruptcy is a legal proceeding under federal law that helps individuals and companies get a fresh start.  It is also a way for failing companies to liquidate their assets and close shop in an orderly fashion.



Importance of the bankruptcy system

Despite all the negative sentiment around bankruptcy, the system is, in fact, necessary to the functioning of our modern economy. Firstly, the system removes the excessive debt burden from both individuals as well as companies. Secondly, bankruptcy also keeps credit moving in the economy. The second point is really important since our economies now survive on credit.

Finally, the Founding Fathers of the United States of America also knew the importance of giving people a fresh start – everyone deserves a chance to start anew and change for the better.


What is bankruptcy and The Importance of The Bankruptcy System?
What is bankruptcy?


The bankruptcy system

The bankruptcy system is run by the US Bankruptcy Courts, which are actually a part of the larger Federal District Court System. Therefore, there is at least one bankruptcy court in each federal district of a state. However, the number of courts will also depend on the population of that area. If it is densely populated district, then there could be multiple bankruptcy courts in one district.



Bankruptcy judges supervise these courts. These judges are appointed by the Court of Appeals of the US. Each judge is appointed for a 14 year term. Upon completing this term, the judge may continue to serve for another 14 years. The judge’s term may also not be extended if the Court of Appeals finds his/her work not up to the mark. The judge also has the right to turn down an offer for a second term.


Bankruptcy Trustee

Trustees are critical to the functioning of the bankruptcy system. So what is a bankruptcy trustee? To understand that, we also need to understand what a bankruptcy estate is.

When a person files for bankruptcy, all his or her assets are put into a bankruptcy estate. The bankruptcy court then appoints a trustee to oversee this estate. 

United States Trustee Programis a federal office that is supervised by the US Department of Justice. This program maintains a list of individuals who are also lawyers or accountants who serve as bankruptcy trustees. Trustees are chosen randomly for each case to prevent any kind of bias – favorable or otherwise.

The trustee has the following role in a bankruptcy proceeding:

  • Selling assets and distributing the proceeds among creditors and lenders


What is bankruptcy discharge?

A discharge is a court order that permanently prevents any lender from trying to collect a debt from you. Basically, your debt has been “discharged” or taken away. The primary goal of any bankruptcy filing is to have debts discharged as much as possible.

This does not mean that all debts will be discharged. There are some debts, called non-dischargeable debts that a debtor has to pay back, no matter what. Examples of non-dischargeable debts are child support, alimony and tax debts.


Types of Bankruptcy

Now that we know what is bankruptcy, we also need to understand the different types of bankruptcy. There are actually 6 different types of bankruptcy:

  • Chapter 7 – Also called liquidation or straight bankruptcy, this is most common type of bankruptcy in the US.
  • Chapter 9 – This type of bankruptcy is used by municipalities, districts, utilities, hospitals and schools.
  • Chapter 11 – Also called reorganization bankruptcy, this is the third most common type of bankruptcy.
  • Chapter 12 – This filing is used by family farmers and fishermen.
  • Chapter 13 – The second most common type of bankruptcy, it is also called “wage earners bankruptcy”.
  • Chapter 15 – this type of bankruptcy is filed when foreign entities are involved.

Bankruptcy gives you a chance to make things right, don’t waste it.