What are the advantages of seeking bankruptcy protection?

A bankruptcy "discharge" makes certain unsecured debts unenforceable against the person who seeks bankruptcy protection.  The legal system in the United States has long held that individuals and even businesses are entitled to a "fresh start" through bankruptcy. We have all been over-optimistic about the future at various stages of our lives.  When things work out, such over-optimism is heralded as courage and bold vision.  But economic circumstances change, forces over which we have no control overwhelm us, and even well-developed plans can fail to produce the results we want.  In 2008, for example, the Small Business Administration reported that approximately 50% of all small businesses fail within the first five years of operation.  Yet we wouldn't want entrepreneurs to stop trying to open and run these businesses.  Small businesses are a crucial part of the economy.

So what are several of the advantages to seeking bankruptcy protection if you find yourself in a financial crisis?

One of the main advantages of seeking bankruptcy protection is called the "automatic stay."  This is an immediate benefit to those in debt who are receiving numerous and sometimes harassing phone calls and letters.  The automatic stay gives the debtor some breathing room while the bankruptcy process proceeds.

What if the collateral to secure a loan is worth less than the loan? In Chapter 11 and Chapter 13 cases, certain liens can be reduced to the value of the collateral rather than the amount of the debt.  This is called "lienstripping."  For example, if a lien secured a $100,000 loan but he security was, several years later, worth only $50,000, the debt can be paid off at $50,000.  There are exceptions, including the most important secured loan most individuals have.  A debt secured only by a lien on the debtor's principal residence cannot be stripped down to collateral value.  If this rule were changed, it would eliminate homeowners leaving bad loans with "deficiency" judgments for the difference between the loan and sale price.  Lienstripping is also prohibited on cars purchased in the prior two and a half years.

Getting good prices for goods or even a business that must be sold to pay debts is crucial.  If assets are to be sold ("liquidated") a sale through a bankruptcy may bring a higher prices.  Businesses, for example, might be sold as going concerns instead of being sold in pieces.  Compared to sales under execution or foreclosure, sales through the bankruptcy estate are often better advertised.

Finally, certain forms of bankruptcy provide a way for individuals, families, and businesses to move forward without closing shop or liquidating.  Under Chapter 11, a business may be able to restructure its debts and reorganize.  Under Chapter 13, an individual or family can consolidate pre-bankruptcy debts and pay them out of future income over a longer period of time.

In future posts, I'll discuss some of the disadvantages of seeking bankruptcy protection.  Whether to seek bankruptcy protection is always a touch choice and involves a serious assessment of the benefits versus the costs.  I suggest seeking experienced legal counsel to help you through this process.