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What is bankruptcy?

Bankruptcy can dismiss debts, or help debtors reorganize their finances.

In the simplest terms, bankruptcy occurs when an individual or a business can no longer afford to pay their bills and may ask the courts to dismiss their obligation to pay their debts.

But bankruptcy is rarely a simple matter, and individuals who are facing this last resort of setting their monetary affairs in order need to understand how the bankruptcy laws work and what the implications will be for their financial futures.

In recent years, bankruptcy has become a more common topic in everyday conversation. As the recession dragged on, record numbers of individuals and businesses were forced to file for bankruptcy in federal courts as they faced insurmountable medical bills, overwhelming consumer debt and business failures.

From June 2010 to June 2011, 1,529,560 bankruptcies were filed in U.S. courts nationwide, according to federal court figures. While that number was fewer than the 1,572,597 filed in the same period from 2009 to 2010, it is part of a steady rise in bankruptcies that occurred during the worst period of the recession.

Traditionally, resorting to bankruptcy was seen as a stigma of financial ruin and disgrace. But as more people began to avail themselves of what the U.S. Bankruptcy Court calls "a fresh start," individuals took advantage of this legal remedy as a way to get back on their feet financially.

The vast number of filings are for personal bankruptcies filed by individuals under Chapter 7 Bankruptcy, which allows the court to seize an individual's assets to pay off their creditors but frees the debtor from further obligation once the case is settled. The bankruptcy allows a certain amount to be claimed as exemptions against major personal assets such as a home or car, so they aren't always seized in the legal action.

Chapter 13 Bankruptcy allows individuals to reorganize their debts and pay them according to a plan approved by the court. This action prevents an individual's assets from being seized by the creditors.

The most common bankruptcy action taken by businesses and corporations is a Chapter 11 reorganization of assets, which allows commercial ventures to continue operating and to protect their assets.

One very important point that should be understood by anyone who considers filing for bankruptcy is that some debts - including mortgages, auto and student loans, taxes, back child support and alimony - are not included in bankruptcies and must still be paid by those in debt.

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