Deciding to declare bankruptcy may be the most important choice of your financial life. But it’s only the first choice. Picking the chapter of bankruptcy that best suits your situation is crucial.
Types of Personal Bankruptcies
Filing as a private individual? Personal bankruptcy generally comes in two flavors, known by their places in the federal Bankruptcy Code: Chapter 7 and Chapter 13.
Chapter 7: Liquidation
Chapter 7 is the most commonly chosen option, with 381,217 cases filed in 2020. That represents 70% of bankruptcies that year. Chapter 7 is straightforward and essentially misnamed.
While the law provides for the sale of certain assets for distribution among creditors, in fact close to 96% of Chapter 7 bankruptcies are considered “no-asset” cases: The filer has no property with sufficient equity to be seized and sold by the court-appointed trustee to pay off creditors.
Chances are, you will keep your property, and depending on how long chapter 7 bankruptcy takes (typically four to six months), you will emerge with all but certain unsecured debts discharged — that is, wiped clean. Alimony, child support, some taxes, liens on property, and student debt (in most cases) will remain. If Chapter 7 does not work out, you can file a second bankruptcy after the time limit expires. There are pros and cons to chapter 7 bankruptcy, so be sure to weigh those against chapter 13 bankruptcy to see which fits your situation better.
Chapter 13: Reorganization
Chapter 13 is for debtors with reliable incomes who want to keep their home or car but have fallen behind on their loan payments. Chapter 13 stops foreclosure and/or repossession actions while filers enter into a court-mandated repayment plan, which will include catching up on back payments and paying off at least a portion of their unsecured debt.
There were 154,341 Chapter 13 cases in 2020, accounting for 28% of the total bankruptcy load. Upon successful completion of the repayment plan — typically three to five years — any remaining unsecured debt (medical bills, credit cards, personal loans) may be discharged. Certain types of debts that are not discharged in Chapter 7 may be discharged in Chapter 13.
Personal Bankruptcy Comparison
Worth noting: Chapter 11 bankruptcy, once only for businesses (see below), is available to individuals with debts above the Chapter 13 limits. Most often, Chapter 11 is the refuge of celebrities, pro athletes, and real estate investors.
|Chapter 7||Chapter 13|
|Type of bankruptcy||Liquidation||Reorganization|
|Who can file?||Individuals, businesses||Individuals (including sole proprietors)|
|Eligibility||Disposable income below Chapter 7’s means test||Unsecured debt less than $419,275; secured debt less than 1,257,850|
|What happens to unsecured debt?||Unsecured debt is discharged||Unsecured debt remaining at end of repayment plan is discharged|
|What happens to property?||Unsecured debt remaining at end of repayment plan is discharged||Debtors may keep all property but must pay unsecured creditors an amount equal to value of nonexempt assets|
|How long does it take?||Generally, four to six months||Payoff plans usually take between three and five years|
|How long does it stay on a credit report?||Up to 10 years after discharge||Up to 7 years after discharge|
|Cost||$338 admin/ fee (trustee, attorney fees, etc.) Total cost: $1,500-$3,000||$313 admin. fee (trustee, attorney fees, etc.)|
Total cost: $3,000-$5,000+
Types of Business Bankruptcies
Business bankruptcies typically fall into one of three categories. Two — Chapter 7 and Chapter 13 — are variations on the personal bankruptcy theme. Chapter 11 bankruptcy is generally for businesses that have hit a bad patch and might be able to survive if their operations, along with their debt, can be reorganized.
Business bankruptcies involve legal entities ranging from sole proprietorships and LLCs (limited liability corporations) to partnerships, professional associations, and corporations.
Chapter 13: Small Business Repayment Plan
Customarily reserved for individuals, Chapter 13 can be used for small business bankruptcy by sole proprietorships because the sole proprietor and the individual are indistinguishable; in the eyes of the law, they exist as one.
The small business that wants to reorganize rather than liquidate files Chapter 13, including a repayment plan that details how debts will be repaid.
The amount that must be repaid hinges on how much you earn, how much is owed, and the value of the property owned.
Why not file Chapter 7 liquidation bankruptcy and be done with it? Chapter 13 protects personal assets, such as a home, which would be exposed to seizure if a sole proprietor filed Chapter 7.
Chapter 7: Liquidation
A business that lacks a viable future and is overwhelmed by obligations is a good candidate for a Chapter 7 business bankruptcy. The owners surrender their business to a court-appointed trustee for an orderly liquidation. Nothing is exempt; everything goes.
At the completion of the process, all obligations — leases, contracts, loans, overdue accounts, credit cards, and other business debts — are generally written off by creditors as all business assets were presumably liquidated. While there is no discharge in business Chapter 7, the practical effect here is that the business’s assets are liquidated and creditors paid to the extent possible.
Unless they have made themselves personally liable for the business’ debts, the former owners are free and clear.
Chapter 11: Business Reorganization
For a business, bankruptcy does not necessarily mean ruin. If it did, there would be three fewer major air carriers (United, Delta, American), two fewer car manufacturers (General Motors, Chrysler), and no Marvel Universe.
Chapter 11 filings — which surged during the coronavirus shutdown in 2020 — allow troubled businesses to protect themselves from creditors while they reorganize their business operations, debts, and assets.
If all goes well, the business re-emerges a few years later — oftentimes smaller, sleeker, more efficient, profitable — and creditors have enjoyed a more satisfactory return than they would have if the business ended operations and was liquidated.
Sometimes, however, Chapter 11 buys only time. The reorganization plan fails, and liquidation results. The 2011 demise of Borders Books, once the nation’s No. 2 bookseller, is a prominent example.
Other Types of Bankruptcies
The bankruptcies listed above are by far the most common. They made up 99.9% of the bankruptcies filed in 2020. There are, however, carveouts in the Bankruptcy Code for debtors in specialty situations. Only 792 of the 544,463 cases filed in 2020 fell in these categories.
Chapter 12: For Family Farmers and Fishermen
Similar in design and intent to Chapter 13, Chapter 12 provides family farmers and family fishermen who meet certain criteria to propose a repayment plan lasting from three to five years.
However, anticipating the seasonal nature of many small farming and fishing operations, Chapter 12 allows more flexibility in structuring periodic payments.
Chapter 12 helps multigenerational families involved in the business in which the parents have guaranteed debt.
Family farmers or fishermen considering Chapter 12 should be aware of several changes that came about in 2019 regarding the sale of assets. It’s a good idea to review these changes with an attorney or an accountant trained in bankruptcy law.
Chapter 15: For Foreign Creditors
A fairly recent addition to the federal Bankruptcy Code, Chapter 15 was adopted to enhance cooperation in international insolvencies. Such filings are rare, but they are useful to parties representing debtors, creditors, and assets involving more than one country seeking efficient and reasonable bankruptcy processes.
A Chapter 15 filing typically is not central to a bankruptcy involving a foreign individual or entity. Instead, it is considered ancillary, the main event unfolding in the foreigner’s home nation.
Chapter 9: For Municipalities
Sometimes, local governments run into financial problems that can’t be solved by some combination of taxes, cuts to services and/or personnel, or floating bonds. In these dire circumstances, these local government entities — including cities, townships, counties, school districts, municipal utilities, taxing districts, and any number of other “instrumentalit[ies] of the state” [11 U.S.C. § 101(40)] — may file for bankruptcy protection.
The goal is to reorganize and possibly even resize debt. For instance, when Detroit filed for bankruptcy in 2013, city pensioners took a slight hit but a major bondholder got a small fraction of the $333 million it was owed. The storied Joe Louis Arena was demolished, and the site surrendered to a bondholder for construction of a hotel.
Although Chapter 9 bankruptcies were once a fixture of the American landscape — about 680 have been filed since 1937 — no city, town, village, or county has filed since July 2013.
But the century is young.
Chapter 9 bankruptcies made the news in April when U.S. Senate Majority Leader Mitch McConnell (R-Ky.) suggested Congress might want to extend bankruptcy protection to states to help alleviate some of the effects of bad management that were exacerbated by the coronavirus shutdown.
Not unexpectedly, the blowback was immediate. From constitutional scholars. And from politicians — Republicans as well as Democrats.
It’s unlikely Chapter 9-for-states could make it through Congress, or would survive a court challenge if it did. But McConnell’s shot across the bow of big-spending states certainly grabbed everyone’s attention.
Anyway, bankruptcy courts are full enough as it stands.
About The Author
Max Fay has been writing about personal finance for Debt.org for the past five years. His expertise is in student loans, credit cards and mortgages. Max inherited a genetic predisposition to being tight with his money and free with financial advice. He was published in every major newspaper in Florida while working his way through Florida State University. He can be reached at [email protected].
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