There are four different types of bankruptcy proceedings that apply to most business and individual situations in the United States (a fifth, Chapter 9, is used by towns or municipalities that cannot pay their debts, and a sixth, Chapter 15, addresses ancillary and other cross-border cases which are beyond the scope of this article). The concept of bankruptcy is the same no matter what the context: a person or business is no longer solvent and cannot pay back creditors to their satisfaction. To maximize the ability of the debtor to honor obligations and to lessen the damage to the creditor, there are different kinds of bankruptcies. These are outlined below:
Chapter 7 (liquidation) is often used as a last resort for a business or individual who has stretched credit to the absolute limit and has nowhere else to turn. Under Chapter 7, debtors give up assets and property. The property is sold, with proceeds used to pay the creditors. Generally, the debts are discharged (meaning eliminated) about three months after the filing. Debts that are not eligible to be discharged include child support payments, some taxes, and student loans. Car loans, house mortgages, and other secured debts are also not discharged. Credit card debt is dischargeable. The 2005 Bankruptcy Reform has made it more difficult to qualify for Chapter 7 bankruptcy, because debtors are subject to a means test, and if their income is greater than limits set by the government, they must file under Chapter 13.
Chapter 11 (reorganization) is typically used by businesses, since it is complicated to pursue and very costly. Chapter 11 is the most desirable form of bankruptcy because it allows the debtor a way out while offering the means to make good on debts in some measure. A trustee is brought in to enact a prescription for the company to stay in business, allowing reorganization and an opportunity to restructure debt and get out from under certain burdensome leases and contracts, and creditors to get their money back before any more money can be invested. Usually, a company is allowed to continue to operate — under the supervision of the court — while it is in Chapter 11.
Chapter 12 is specifically for the reorganization of family farms. It is only available to individuals who meet the description of family farmer described in the statute, and a number of requirements must be met in order to be eligible. It is modeled after Chapter 13, which is the chapter of the Bankruptcy Code designed for wage earners, but it has a higher debt ceiling.
Chapter 13 is a three-to-five-year debt repayment plan that is most often claimed by individuals. The goal of Chapter 13 is to enable debtors who still have income a means to rehabilitation, provided they fulfill a court-approved plan. The assets of the debtor are protected and a wider range of debts become dischargeable. In return, the debtor must make a monthly payment of his or her disposable income, over a three-to-five-year period. During this time, the creditors cannot attempt to collect the previously incurred debt except through the court. Usually, the individual gets to keep his or her property, and the creditors end up with partial payment. Chapter 13 is often a good alternative in cases where credit counseling or Chapter 7 are not options, and where there is enough disposable income to fund a viable plan. Some of the advantages to the debtor in filing Chapter 13 versus Chapter 7 are that it stops foreclosure and offers the possibility of a discharge of debts of kinds not dischargeable under Chapter 7.
A downside to filing for personal bankruptcy is that a record stays on the debtor’s credit report for 10 years, which may make credit less available or the terms less favorable. Additionally, the debtor is not allowed to obtain additional credit without permission of the trustee. This disadvantage applies both to debtors in a Chapter 11 case as well as those who are in or have recently been in a Chapter 7 case. That must be balanced against the removal of debt from the debtor’s record, which tends to improve creditworthiness.