selective focus of what bankruptcy chapter to file form, gavel, calculator and coins on brown wooden table
27 Jun 2024

What Bankruptcy Chapter to File – Chapter 7,11, or 13?

Navigating the complexities of bankruptcy can be daunting, yet it’s a necessary step for many individuals and businesses seeking relief from insurmountable debt. The U.S. Bankruptcy Code offers several paths to financial recovery, prominently through Chapters 7, 11, and 13, each designed with specific circumstances in mind. This article sheds light on the differences between these options, providing a clear comparison to help you or your business determine what bankruptcy chapter to file. With the right choice, bankruptcy can offer a beacon of hope, leading to a more manageable financial future.


What Bankruptcy to File: Chapter 7,11, or 13?

Chapter 7 Bankruptcy: Liquidation

Chapter 7 bankruptcy, often referred to as “liquidation” bankruptcy, is designed to provide relief to individuals and businesses overwhelmed by debt. The primary goal of this chapter is to settle debts by liquidating the debtor’s non-exempt assets. This process allows debtors a fresh start by clearing most of their existing debts (with some exceptions like student loans and alimony).

To qualify for Chapter 7, applicants must pass a means test, which compares their income to the median in their state for their household size; if their income is too high, they may have to file under a different chapter.

Other eligibility criteria include not having had a bankruptcy petition dismissed in the previous 180 days due to willful failure to appear before the court or comply with orders, and receiving credit counseling from an approved agency within 180 days before filing.

Pros:

  • Rapid path to debt relief, typically taking about 4-6 months from filing to discharge
  • Can stop foreclosure on a home temporarily, though it may not permanently prevent foreclosure if the debtor cannot catch up on payments.
  • Cons:

  • Liquidation of non-exempt assets can be painful for those with valuable property not covered by exemptions.
  • Prolonged negative impact on one’s credit score, making it difficult to obtain credit, buy a home, or sometimes secure employment for several years.
  • Not all debts can be discharged under Chapter 7, including most student loans, certain taxes, child support, and alimony.
  • The Process of Chapter 7 Bankruptcy

    The process starts by filing a petition in bankruptcy court. Debtors must submit documents detailing assets, debts, income, expenditures, and financial situation. Once filed, an automatic stay halts most collection actions against the debtor or their property.

    A bankruptcy trustee is appointed to oversee the case and is tasked with examining the debtor’s submissions, selling off non-exempt property to pay creditors, and disputing any aspects of the case, such as non-dischargeable debts.

    Depending on state laws debtors can keep exempt property necessary for daily life, like a basic car, work tools, and some home equity. Non-exempt assets, which might be sold, can include a second car, vacation home, stocks, or valuable collectibles.


    Chapter 11 Bankruptcy: Reorganization

    Chapter 11 bankruptcy, often termed “reorganization” bankruptcy, is primarily aimed at businesses, allowing them to continue operating while restructuring their debts. This chapter allows a business to remain operational, retain its employees, and maintain its value as an ongoing entity while it engages in discussions with creditors to restructure its debt terms. It’s also available to certain high-debt individuals who exceed the debt limits of Chapter 13.

    Both businesses (including corporations, partnerships, and sole proprietorships) and individuals can file for Chapter 11 if they face overwhelming debt but seek to restructure rather than liquidate. Unlike Chapter 13, there are no explicit debt limits for filing under Chapter 11, making it suitable for large-scale reorganizations.

    Pros

  • Offers significant flexibility, allowing businesses to renegotiate terms with creditors, retain assets, and continue operations.
  • Provides a lifeline for businesses that, despite being financially distressed, have viable underlying operations.
  • Cons

  • The process is notably complex and lengthy, often taking several years to complete.
  • Costs involved, including legal fees and court costs, can be substantial, making it a less accessible option for smaller businesses.
  • The administrative burden of complying with reporting requirements and court oversight can also be burdensome.
  • The Process of Chapter 11 Bankruptcy

    The bankruptcy process starts when a bankruptcy court receives a petition, either voluntarily filed by the debtor or involuntarily by creditors. After the petition, the debtor must submit detailed financial information and propose a reorganization plan. This plan outlines the company’s future operation strategies and how it intends to pay off debts.

    Chapter 11 bankruptcy features the “debtor in possession” concept, allowing the debtor to keep control over business operations and assets during reorganization, under court supervision. A creditors’ committee might be set up to protect unsecured creditors’ interests, helping negotiate the reorganization terms.

    For the plan to advance, it needs court approval, to demonstrate its fairness and feasibility. Once approved, the debtor must follow the plan, typically involving payments to creditors over several years.


    Chapter 13 Bankruptcy: Repayment Plan

    Chapter 13 bankruptcy, often known as the “wage earner’s plan,” allows individuals with regular income to develop a plan to repay all or part of their debts. Unlike Chapter 7, which involves liquidating assets to pay off debts, Chapter 13 focuses on debt adjustment and allows debtors to keep their property while making structured payments to creditors over three to five years.

    To be eligible for Chapter 13 bankruptcy, individuals must have a stable and regular income sufficient to cover their monthly expenses plus their repayment plan. There are also debt limits for Chapter 13 filers; as of this writing, unsecured debts must be less than $419,275, and secured debts must be less than $1,257,850. These amounts are adjusted periodically for inflation.

    Pros

  • Keep valuable assets, like a home or car, which might otherwise be lost to liquidation under Chapter 7.
  • Triggers an automatic stay that immediately stops most collection actions, including lawsuits, wage garnishments, and harassing phone calls from creditors.
  • Cons

  • Long commitment to a fixed payment plan that can last up to five years.
  • Debtors must adhere to a strict budget and get approval from the trustee for major financial decisions, such as taking out new loans or selling major assets, significantly restricting the debtor’s financial flexibility.
  • The Process of Chapter 13 Bankruptcy

    The debtor outlines a repayment strategy, specifying how they intend to settle their debts over a span of three to five years. This strategy necessitates dedicating a portion of the debtor’s future earnings to repaying debts, prioritizing obligations like taxes and child support.

    Upon submission, both the bankruptcy trustee and the creditors scrutinize the proposed plan. It then requires the court’s approval during a confirmation hearing. The trustee is tasked with the distribution of the debtor’s payments to the creditors, adhering to the agreed terms of the plan.

    Completing all payments as stipulated by the confirmed plan results in the debtor being absolved of the remaining dischargeable debts. Consequently, they are no longer under any legal obligation to pay those debts included in the bankruptcy filing.


    Side by Side Comparison – Chapters 7, 11, and 13 Bankruptcy

    Eligibility Requirements and Process Overview

  • Chapter 7 is available to individuals and businesses with limited or no ability to repay debts. The process involves liquidating non-exempt assets to pay off creditors. Eligibility is determined by a means test for individuals to ensure their income is below a certain threshold.
  • Chapter 11 primarily targets businesses seeking to reorganize while continuing their operations, though it’s also available to individuals with debts exceeding Chapter 13 limits. This complex process allows companies to propose a plan to keep the business alive and pay creditors over time.
  • Chapter 13 is designed for individuals with regular income who can pay back part of their debts through a repayment plan. Debtors must have debt amounts below specific thresholds and propose a repayment plan based on their income.
  • The Outcome for Debtors’ Assets and Debts

  • Chapter 7 results in the liquidation of non-exempt assets. Most unsecured debts are discharged, but certain obligations, like student loans and taxes, may remain.
  • Chapter 11 enables businesses and individuals to retain their assets while restructuring their debts. Confirmation of the reorganization plan by the court allows the debtor to modify loan terms and discharge some obligations.
  • Chapter 13 allows debtors to keep their assets, including homes and vehicles, by adhering to a 3-5-year repayment plan. Upon completion, the remaining qualifying debts are discharged.
  • Duration and Overall Impact on Debtors’ Future Financial Status

  • Chapter 7 is the quickest path, typically concluding within 4-6 months. However, it can significantly impact one’s credit score and ability to obtain new credit, staying on the credit report for up to 10 years.
  • Chapter 11 can last anywhere from a few months to several years, depending on the complexity of the case and the time needed to confirm the reorganization plan. It’s costly and can impact the debtor’s credit and business reputation.
  • Chapter 13 takes 3-5 years due to the length of the repayment plan. Completing the plan can improve the debtor’s financial status by reducing debt load and may have a less severe impact on credit than Chapter 7.
  • Each bankruptcy chapter serves different needs and offers various paths toward financial recovery. The choice depends on the debtor’s situation, objectives, and long-term implications of each bankruptcy type on their future financial status.


    Final Thoughts

    Choosing the right bankruptcy chapter is crucial for effectively managing and overcoming financial challenges. Different bankruptcy options cater to varied needs, offering paths to eliminate or restructure debt while considering asset retention and future impact.

    Given the complexity and significant consequences of declaring bankruptcy, it is critical to conduct a comprehensive assessment of one’s financial circumstances when choosing what bankruptcy chapter to file. It is strongly advised to seek expert legal counsel to ensure decisions are well-informed and aligned with personal or business financial objectives. By adopting this approach, the debtor can secure a more beneficial result, harmonizing immediate relief with sustained financial well-being.