What it means
Bankruptcy gives individuals a way to clear many debts and make a fresh start. The court issues a discharge, which is an order releasing the person from legal responsibility for specified debts.
Not every debt qualifies, and the ones that do not are called non-dischargeable. The reasons are mostly public policy.
Courts and legislators protect certain creditors, such as children owed support, government agencies owed recent taxes or lenders who were deceived. Debts caused by fraud, certain penalties and harm caused deliberately can also be excluded.
Student loans are the best-known example. In the United States they are generally non-dischargeable, with an exception if repayment would cause undue hardship, a standard that is hard to meet.
Other countries treat student debt differently, so the rules depend on where the borrower lives. For individuals, the practical effect is that bankruptcy may not remove the debts that weigh most.
A person with $80,000 of debt may find that only part of it can be discharged. Planning for the remainder is essential, and a lawyer can explain which items fall into which group.
Business owners should note the link with personal guarantees and certain payroll taxes. Directors who guarantee a company loan become personally liable, and some tax debts follow the individual even if the business fails.
Reading the small print before signing is much cheaper than discovering this afterwards. Employers and finance teams may also meet the issue when dealing with staff wage deductions or debt recovery.
Support payments, for example, are often enforced through payroll. Knowing that these debts survive bankruptcy helps managers explain why they continue.
In practice
Real-world examples.
Example
A graduate has $60,000 of student loans and $20,000 of credit card debt. She files for bankruptcy and the card debt is discharged. The student loans remain, and she arranges a repayment plan. She keeps all the paperwork from the process so that future lenders can see the history.
Example
A business owner owes $40,000 in recent payroll taxes. Even after personal bankruptcy, the tax debt survives because certain recent taxes are excluded from discharge. He negotiates an instalment plan with the tax authority. The authority agrees because he has been honest about his position and has started making payments.
Example
A man who borrowed $25,000 by providing false information on an application later files for bankruptcy. The court rules that the debt arose from fraud and is non-dischargeable. He still owes the full amount. Making false statements to obtain a loan can also lead to criminal action.
Formula
Calculation
Debt remaining after bankruptcy = total debt - dischargeable debt
A person owes $80,000 in total, made up of $30,000 of credit cards, $35,000 of student loans and $15,000 of overdue child support. Credit cards are dischargeable, but the student loans and child support are not. Debt remaining after bankruptcy = 80,000 - 30,000 = $50,000, which is 35,000 + 15,000.Case study
Seen in the real world.
Dalton Home Services is a fictional company run by a sole trader, Peter, who personally guaranteed a $120,000 business loan and also owed $30,000 in credit card debt and $18,000 in student loans. In this illustrative story, the business failed and Peter filed for personal bankruptcy. His lawyer explained that the credit cards would be discharged but the student loans would not.
The guarantee was dischargeable in his case, since it was an ordinary contractual debt. After bankruptcy, Peter owed only the $18,000 student loan, down from $168,000. The lawyer advised him to build a repayment plan for that balance and to keep records, so that new lenders could see the improvement.
Following the bankruptcy, Peter attended a short financial education course offered by a local charity. He learned to build an emergency fund, track his spending and negotiate a repayment schedule with the student loan servicer. Two years later he had cleared a third of the student loan and was able to qualify for a small business loan on conventional terms.
Watch out
Common mistakes.
- Assuming bankruptcy wipes out every debt. Several categories survive the process.
- Taking on new debt through dishonesty before filing. Debts incurred by fraud are generally non-dischargeable.
- Ignoring the difference between countries. Rules on student debt and taxes vary widely.
Questions
People also ask.
What are common non-dischargeable debts in the United States?
Child support, most student loans, certain recent taxes and debts arising from fraud or deliberate harm. The list is set by law, so it is worth checking the current rules for your country.
Can a non-dischargeable debt ever be removed?
Sometimes, such as through proving undue hardship for student loans, but the standard is high.
Should I seek advice before filing for bankruptcy?
Yes, because a lawyer can explain which of your debts will survive and what alternatives exist. Options such as a repayment plan or negotiated settlement may suit some debts better than bankruptcy.
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