When an individual or company does not have the funds to pay their creditors and there are no obvious and immediate means by which such funds can be raised they can file for bankruptcy.
Bankruptcy allows the debtor to resolve his debts through the division of his assets among his creditors. Additionally the declaration of bankruptcy allows debtors to be discharged of most of the financial obligations, after their assets are distributed, even if their debts have not been paid in full.
Bankruptcy in the USA
Bankruptcy is federal statutory law (Title 11 of the United States Code) based on the Constitutional requirement for "uniform laws on the subject of Bankruptcy throughout the United States." (Article I, Section 8). Bankruptcy proceedings are undertaken in the United States Bankruptcy Courts, part of the District Courts.
There are two basic types of proceedings that can either be entered into voluntarily by the debtor or be started by any creditor by filing a petition. Liquidation under a Chapter 7 filing is the most common form of bankruptcy. Liquidation involves the appointment of a trustee who collects the non-exempt property of the debtor, sells it and distributes the proceeds to the creditors. Bankruptcy under Chapters 11, 12, or 13 is more complex and involves allowing the debtor to use future earnings to pay off creditors.