Bankruptcy refers to a legal declaration of inability to meet existing debt obligations. Indeed, bankruptcy has several implications, depending on the type of bankruptcy selected (six types under US law). Bankruptcy might seem to be attractive. Advantages of it include the possibility that debt might be written off, protection from creditors, and the opportunity to make a fresh start.
Disadvantages such as loss of assets (including businesses), loss of status, your financial struggles being made public, and difficulty getting credit in future, take the gloss off the bankruptcy option. Before filing for bankruptcy, an individual must weigh the merits and demerits. In addition, several alternatives to bankruptcy should be considered in the context of the debtor’s circumstances. The alternatives range from taking no action to creating debt management plans.
• Debt settlement
This is the most common, and effective alternative to bankruptcy. It is an approach to debt reduction whereby a reduced balance is accepted as payment in full by the creditors. Naturally, this involves negotiating with creditors to reach consensus over what is an acceptable settlement amount. Creditors would be willing to negotiate, since their chances of recouping some of their funds are far than litigation – particularly when the debtor would have no means of paying the judgement. In cases where there is mutual benefit to the debtor and creditor from a settlement, negotiations would likelier occur in good faith. In the UK, debt settlement is in the form of Individual Voluntary Arrangements (IVAs).
• Debt consolidation
This is the debt reduction strategy of taking one large loan (usually on more favourable terms) to pay off smaller loans. The advantage of this is that the individual has fewer creditors and can take advantage of lower interest rates. However, if this is not accompanied by a change in lifestyle/ spending habits, it would simply lead to more debt. Another major disadvantage to debt consolidation is that if secured debt (home equity) is used to consolidate several unsecured debts, this can lead to asset loss if the debtor defaults on the secured loan.
• Take no action
In certain cases, a debtor might be unable to pay because of lack of assets and income. In those circumstances, a creditor has little to gain from seeking a court judgement against a debtor, since there aren’t even any wages to garnish. If the debtor is not going to possess assets or generate income in the foreseeable future, the wait-and-see approach can be taken against them. However, this alternative is only viable if the debtor is “judgement proof.”
• Debt Relief Orders (UK)
According to insolvency.gov.uk, Debt Relief Orders is a recent provision in the UK for those who have small debts (under 15,000 pounds sterling) that they are unable to repay. Those who do not have property, limited surplus income can apply for some relief. The order provides relief for up to 12 months, thus providing only temporary relief from creditors.
• When to use bankruptcy alternatives
It is important to use debt relief or reduction strategies that suit your finances and circumstances. Generally the following criteria help to determine the suitability of bankruptcy and whether an alternative is better:
* Age: The older you are, the better filing for bankruptcy might be
* Number of dependents
* Size of debt: Larger debts are better candidates for bankruptcy proceedings
* Asset reserves
* Amount of non-dischargeable debt
Bankruptcy is not the only option for individuals in financial distress. Individuals must consider age, the size and type of debt, asset reserves and the financial implications before filing for bankruptcy. Many individuals in the past abused bankruptcy, and filing for bankruptcy is a more rigorous process now. If you can avail yourself of alternatives, it would be prudent to do so. Bankruptcy should be perceived as a last resort.