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What Is the Act of Bankruptcy?

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  • Written By: Renee Booker
  • Edited By: E. E. Hubbard
  • Last Modified Date: 22 December 2018
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    Conjecture Corporation
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Under the laws of many legal systems, the act of bankruptcy refers to the legal process by which an individual or company declares the inability to pay debts owed to creditors. In some jurisdictions, an act of bankruptcy may only be filed by a business, while, in others, both individuals and businesses may file for bankruptcy protection. In most legal systems, bankruptcy requires the debtor to liquidate, or forfeit to the court, most of his or her assets to be used by a trustee to pay creditors. Prior to the modern day bankruptcy codes found in many countries throughout the world, it was not uncommon for someone to be sent to debtor's prison or turned into a slave if he or she was unable to pay a debt.

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Within the United States, the United Kingdom, Canada, and many other countries with former ties to the United Kingdom, the act of bankruptcy is very similar. In the United States, a debtor must file a petition under one of the six possible chapters found within the United States Bankruptcy Code. A Chapter 7 bankruptcy is known as a liquidation and is intended for individuals with low income and little to no assets. A Chapter 13 is considered an "individual debt adjustment" and is used for individuals with significant income or assets who are able to pay back a substantial portion of the debt over time, while a Chapter 12 is for family fisherman or farmers. Chapters 9, 11, and 15 are for corporations, partnerships, municipalities, or cross-border cases.

When an act of bankruptcy is filed, all known creditors are notified of the filing. An immediate and automatic stay is also issued by the court preventing any further collection efforts by creditors until further notice from the bankruptcy court. A meeting of creditors will be set where any objections to the request for bankruptcy protection may be filed.

Depending on which chapter was filed, assets of the debtor may be sold by the trustee who has been appointed by the court. Some assets are exempt from sale such as equity — up to a certain level — in a primary residence and some personal items. If the bankruptcy is a Chapter 7, the bankruptcy will be discharged at some point after the meeting of creditors and all eligible debts will be discharged, meaning the debtor does not have to pay them. Most other chapters require the debtor to formulate an acceptable repayment plan with the court before discharge. Some debts are not eligible for discharge under an act of bankruptcy in the United States, such as student loans or child support.

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