What is Personal Bankruptcy?

Contrary to conventional wisdom, personal bankruptcy filing doesn't necessarily discharge a debtor of all outstanding obligations to creditors. Indeed, there are certain debts that even "super discharging" forms of bankruptcy cannot absolve. Certain types of student loans (called secured student loans) must be paid even after a bankruptcy filing. Taxes to the state or local or federal government must also be paid. Similarly, child support payments and moneys owed to victims of drunk driving accidents must be fully remunerated, Chapter 7 and Chapter 13 bankruptcy filings do not protect debtors in these situations.

Typically, however, personal bankruptcy filings erase unscheduled debts. Thus, creditors, including credit card companies, auto lenders, and personal friends who have lent money, must line up in a queue to receive proceeds from the bankruptcy estate of the debtor. Privileged creditors typically get paid out first. General creditors, on the other hand, must wait in line for proceeds from personal bankruptcy sell offs to be paid. In cases in which a personal estate is diminished to the point that only privileged creditors receive any remuneration, general creditors may not even receive a penny.

Given the perceived inequity of such situations, general creditors often band together to “jump the line" and receive some payment from the debtor's estate. Creditors who get short shrift may often set their sights on assets that debtors contend are exempt. States set terms of exemption, but both debtors and their creditors can head to court if a party believes that a particular asset is or is not exempt under the title.

Personal bankruptcy settlings can be further confounded by the introduction of business related expenses and bankruptcy filings. It's possible for individuals to simultaneously file a personal 7 bankruptcy and a Chapter 11 bankruptcy for a company. In complicated cases, laws governing exemptions may collide, and legal sparks can fly.

The stain of personal bankruptcy can remain on a debtor's credit report for years and lead to financial headaches (e.g. ballooned interest rates) that can make it very hard for even a discharged individual to regain a high standard of living. That said, personal bankruptcy law is designed to give debtors new starts, and it's possible to rebound post bankruptcy.