In the United States, bankruptcy is a legal process for settling debts between a debtor and his or her creditors. Current bankruptcy law, based on the Bankruptcy Code of 1978, is designed to relieve honest debtors of their burden -- by either erasing debts or negotiating partial repayment -- and offer the chance for a fresh start.
Bankruptcy was not always such a "liberating" experience. As early as Roman times, bankruptcies were forced on merchants who couldn't pay their debts, and their assets were seized and sold to pay off creditors. As recently as the mid-1800s, insolvent Americans could be thrown in debtors' prisons if they couldn't pay off their creditors [source: Encyclopaedia Britannica].
Today, bankruptcies are voluntary. A person chooses to file bankruptcy when there is no hope of paying medical bills, credit card balances and other insurmountable debt. Bankruptcy offers certain legal protections for debtors [source: Nolo]:
- Creditors can't sue the debtor.
- Collection agencies must stop contacting the debtor.
- Foreclosure or eviction proceedings are often halted.
- The debtor's wages cannot be garnished.
- The debtor's utilities cannot be disconnected.
During bankruptcy proceedings, a bankruptcy court determines the best method for satisfying creditors without stripping the debtor of basic necessities. In the end, any remaining unpaid debt is discharged. While bankruptcies offer a fresh start, they leave a deep scar on your credit report that can make it difficult to qualify for credit in the future.