Choosing the Right Type of Bankruptcy
In many cases, the type of bankruptcy filed will be contingent on two things: Your income and your assets. Your income is important because it may preclude you from filing a simple Chapter 7 case, and your assets are important because if you have nonexempt property, you might lose it in Chapter 7, but can protect it in Chapter 13.
Individuals usually reorganize under Chapter 13, which offers a streamlined plan at modest cost that allows the individual to keep possession of his assets, catch up on secured debt, and discharge unsecured debt at the end of the plan
Here are a few scenarios that explore which bankruptcy strategy would be best:
1. Unemployed Debtors with Few Assets – Chapter 7
Loss of income combined with a large amount of debt is the number one reason people file for bankruptcy. Compounding factors like divorce, medical emergencies, or the death of a family member are also common. Assume that in this scenario the debtor has no income other than unemployment benefits, does not own a home, and has one car with a loan against it.
In cases like this, a Chapter 7 bankruptcy is the fastest, easiest, and most effective means of getting rid of debt. As a matter of fact, this is the most common bankruptcy case, often called a "no asset" bankruptcy.
2. Unemployed Homeowners – Upside-Down Mortgage – Chapter 7
Homeowners who are experiencing a loss of income also have options under bankruptcy law. For those homeowners whose property value has fallen below the value of the loan against it, Chapter 7 is probably still the best option. Since the value of the home is less than the value of the lien against it, the homeowner has no equity in the bankruptcy estate, so the house is protected from liquidation. A Chapter 7 bankruptcy can quickly relieve them of their obligations to repay unsecured debts, making monthly bills much more manageable.
3. Unemployed Homeowners – Significant Equity – Chapter 7 or 13
If a homeowner has a significant amount of equity in property, then Chapter 7 may or may not be the best option. If the homeowner's state exempts a generous amount of home equity, then the home may be safe. But if the state homestead exemption doesn't cover the equity, the homeowner may lose the home in a Chapter 7 bankruptcy. The homeowner can keep the home in Chapter 13 bankruptcy if he or she keeps current on the mortgage. Keep in mind though, there must be enough income available from the petitioning household to fund a repayment plan.
4. Employed Homeowners Facing Mortgage Delinquency or Foreclosure – Chapter 13
For homeowners who have fallen behind on mortgage payments, Chapter 13 offers a way to catch up or "cure" past due mortgage payments while simultaneously eliminating some portion of dischargeable debt. This means they can save the home from foreclosure and get rid of a lot of credit card debt, medical debt, and possibly even second and third mortgages or HELOCs. Chapter 7 bankruptcy does not provide a way for homeowners to make up mortgage arrears.
5. Wealthy Petitioners with a Large Amount of Debt - Chapter 11
Very wealthy debtors often need to file under Chapter 11 due to the debt and income limits of Chapter 7 and Chapter 13 bankruptcies.
Once you've decided that bankruptcy is the right solution for your financial situation, you will need to decide which type of bankruptcy is best. If you are an individual or a small business owner, then your most obvious choices are Chapter 7 "liquidation" bankruptcy or Chapter 13 "wage earners" or "reorganization" bankruptcy. We'll go over the pros and cons of each, the eligibility rules, and give you some information to help decide which would be best for you given your financial situation.
There are a select few other types of bankruptcies that are available under certain circumstances, and we will touch on those as well.
Chapter 7 Bankruptcy
Basics: A Chapter 7 bankruptcy will discharge most types of unsecured debt. The trustee will sell any significant nonexempt property in order to repay your creditors.
Time Frame: A typical Chapter 7 bankruptcy case takes three to four months to complete. In the end your debts may be discharged.
Property: Many Chapter 7 debtors keep all or most of their property. Petitioners with significant equity or assets that are not exempt by law could lose them to satisfy some debts.
Your Income: Some high income earners won't be eligible for Chapter 7.
Homeowners/Foreclosures: Chapter 7 can temporarily stop foreclosure, but unless you can get current on your mortgage, the foreclosure will eventually continue.
Eligibility: Chapter 7 is available to those whose income is less than the median of their state, or those who can pass the means test.
Filing Complexity: Filing for Chapter 7 involves preparing a large set of forms and navigating some tricky legal issues, but simple cases can be done pro se - that is, without hiring an attorney.
Chapter 13 Bankruptcy
Basics: In Chapter 13 bankruptcy, you repay your creditors (some in full, some in part) through a Chapter 13 repayment plan
Time Frame: The Chapter 13 payment plan lasts three or five years (depending on your income). At the end, many of your unsecured debts will be discharged.
Property: No property is liquidated under a Chapter 13 bankruptcy.
Your Income: Chapter 13 requires a regular income for the monthly payment.
Homeowners/Foreclosures: Chapter 13 can stop a foreclosure and you can make up past due mortgage payments through your repayment plan.
Eligibility: Chapter 13 has no income requirement, but unsecured debt must be below $383,175 and secured debt below $1,149,525.
Filing Complexity: Chapter 13 bankruptcy involves submitting a repayment plan to the court, and will almost always require hiring an attorney to complete successfully.
Chapter 11 bankruptcy is a form of bankruptcy reorganization available to individuals, corporations and partnerships. It has no limits on the amount of debt, as Chapter 13 does. It is the usual choice for large businesses seeking to restructure their debt.
The debtor usually remains in possession of its assets, and operates the business under the supervision of the court and for the benefit of creditors. The debtor in possession is a fiduciary for the creditors. If the debtor's management is ineffective or less than honest, a trustee may be appointed.
A creditors committee is usually appointed by the U.S. Trustee from among the 20 largest, unsecured creditors who are not insiders. The committee represents all of the creditors in providing oversight for the debtor's operations and a body with whom the debtor can negotiate an acceptable plan of reorganization.
A Chapter 11 plan is confirmed only upon the affirmative votes of the creditors, who are divided by the plan into classes based on the characteristics of their claims, and whose votes are a function of the amount of their claim against the debtor.
If the debtor can't get the votes to confirm a plan, the debtor can attempt to "cram down" a plan on creditors and get the plan confirmed despite creditor opposition, by meeting certain statutory tests.
Chapter 11 is probably the most flexible of all the chapters, and as such, it is the hardest to generalize about. Its flexibility makes it generally more expensive to the debtor. The rate of successful Chapter 11 reorganizations is depressingly low, sometimes estimated at 10% or less.
Chapter 11 is similar to the Chapter 13 repayment bankruptcy, but designed for specific debtors.
Chapter 11 bankruptcy is another form of reorganization bankruptcy that is most often used by large businesses and corporations. Individuals can use Chapter 11 too, but it rarely makes sense for them to do so.