Different Chapters of Bankruptcy

While the phrase "filing for bankruptcy" is often used as blanket term for individuals and businesses, the fact is that there are several different types of bankruptcy. Before determining that declaring bankruptcy is the best course of action, a debtor must consider which type of bankruptcy will benefit him most.

Chapter 7 "Liquidation" Bankruptcy

In a Chapter 7 bankruptcy, an individual debtor asks the Bankruptcy Court to discharge (or cancel) all their existing debt. It is often referred to as the "fresh start" or "liquidation" chapter of bankruptcy. In return, the debtor turns over all his non-exempt property to the bankruptcy trustee. The bankruptcy trustee then liquidates the debtor’s non-exempt property in order to pay all or a portion of the existing debt. Any debt remaining after the debtor’s assets have been applied to the outstanding debt is discharged.

The definition of “exempt” property (that which does not have to be turned over to the bankruptcy trustee for liquidation) varies from state-to-state. However, exempt property typically includes some portion of the equity on the debtor’s residence, furniture, household items, and personal effects.

Following a change to the U.S. Bankruptcy Code in 2005, there are now many more restrictions on who can file for Chapter 7.  Additionally, the Bankruptcy Code now requires those who file for Chapter 7 to undergo credit counseling and financial education courses.

Chapter 9 Bankruptcy (Municipalities)

Chapter 9 bankruptcy was created to help municipalities avoid financial disaster. Chapter 9 is available only to municipalities and is a reorganization rather than a liquidation. Reorganization allows a municipality to pay back all or a portion of its debts over time and under the protection of the Bankruptcy Court. Accordingly, the municipality can settle its debts and rework its finances with minimal disruption to the residents of the town.

Chapter 11 Bankruptcy (Individual or Business)

Chapter 11 bankruptcies are usually filed by businesses, but occasionally are utilized by individuals with significant assets. Like a Chapter 9 bankruptcy, Chapter 11 is not a liquidation, but rather a reorganization.

In Chapter 11, the debtor maintains control of the day-to-day operations of the business or the individual’s estate.  However, at the same time the business or estate continues to function, the debtor, creditors, and bankruptcy trustee work with the Bankruptcy Court to establish a plan to repay some or all of the debt owed to the creditors over an extended period of time.

Chapter 12 (Farms and Fisherman)

Like Chapter 7, a Chapter 12 bankruptcy is designed to be available to a very specific group of people; namely “family farmers” and “family fisherman.” Chapter 12 is a reorganization, which allows debtors who work as family farmers or family fisherman, and who have a steady stream of annual income, to pay back all or a portion of their debts over an extended period of time.

In creating Chapter 12 bankruptcy, Congress sought to tailor a bankruptcy process to be most beneficial to famers and fisherman, who often have significant debt due to the purchase of large pieces of machinery.

Chapter 13 (Individual "Wage Earners" Bankruptcy)

Chapter 13 bankruptcy is an option for those individuals with a steady stream of income who do not wish to liquidate their non-exempt assets or who do not qualify to file for Chapter 7. In Chapter 13, individuals retain their property, but must devote a certain portion of their income to the repayment of all or a portion of their outstanding debt. 

Typically, the repayment period under Chapter 13 lasts no longer than 3-5 years.  Chapter 13, like Chapter 7, often does not require the repayment of unsecured debt (credit cards), and such debt is frequently discharged. What debt, if any, remains after the repayment period is over is often discharged.

Choosing Between Chapter 7 and Chapter 13 Bankruptcy

Previously, debtors with a steady income who wished to retain their property filed for Chapter 13, while those who wished to discharge all their debt and liquidate their property filed for Chapter 7. However, as a result of the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005, it is far more difficult to file for Chapter 7 than it once was.  Debtors wishing to file for bankruptcy under Chapter 7 must pass a “means test.” Under the means test, a formula is applied to the debtor’s income and assets to determine if the debtor is able to make minimum payments to his creditors. If so, the debtor must file for bankruptcy under Chapter 13.

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