To understand how the bankruptcy system works, it can be helpful to learn what it's intended to accomplish. Any bankruptcy attorney will tell you there are fundamentally two different forms of the process: liquidation and restructuring. Each serves a particular purpose, and they're not mutually exclusive. Here's what a bankruptcy lawyer would tell you about why each option exists.
Liquidation
Bankruptcy liquidation efforts are conducted under Chapter 7. This process is most commonly used by individuals, but it is also available to sole-proprietor businesses, partnerships, and even corporations. Generally, businesses avoid Chapter 7 unless they don't have substantial assets to work with.
The goal of liquidation is to get to a clean slate. A judge will appoint a trustee to oversee the process, and the trustee's job is to ensure that your creditors get as much of what's owed to them as possible. However, once all non-essential items are sold, the trustee will tell the court the process is completed. Any remaining debts after that point will be discharged by the court.
Put more simply, liquidation is something of the nuclear option. It's the choice you make when there's no hope of every paying your debts off.
Due to its dramatic nature, Chapter 7 is not available to everyone. You will have to provide documents showing that your income is insufficient to pay down your debts, although folks who make less than their state's median income are usually presumed to be eligible.
Restructuring
The main goal of restructuring someone's debts is to buy them enough breathing room to pay things off over time. Restructuring is available to individuals under Chapter 13, most businesses under Chapter 11, and farms under Chapter 12.
In this scenario, you and your bankruptcy lawyer would submit a repayment plan to the court. You'll have to consistently pay every month on the plan, but your total obligations will be reduced to a lower amount. For example, someone might restructure using 85% of the current debts as their target. Your creditors would be out the remaining 15%, but they'd get most of what you owe them.
Not Mutually Exclusive
When someone fails to pull off a structuring plan, they usually have the option to liquidate. Also, some folks will immediately file for Chapter 7 liquidation to discharge their unsecured debts and subsequently pursue Chapter 13 to restructure their secured debts. A bankruptcy attorney can help you figure out which route you'll want to try.
