The United States Code or the Federal Bankruptcy Code has four bankruptcy filings in its Title 11, namely:
Chapter 7 on Liquidation;
Chapter 11 on Reorganization;
Chapter 12 on Adjustment of Debts of a Family Farmer with Regular Annual Income;
and Chapter 13 on Adjustment of Debts of an Individual with Regular Income.
In this article we are going to discuss only the three most commonly filed bankruptcy: Chapter 7, Chapter 11, and Chapter 13.
Chapter 7 bankruptcy – Liquidation:
This is the most common of all bankruptcy cases being filed as it is applicable to married couples, individuals, and companies. A debtor who files for Chapter 7 bankruptcy aims to start over paying his debts by writing off as much as possible and starting with a new clean slate.
In chapter 7, a trustee or administrator takes charge of the sale of the debtor’s assets to pay the debtor’s obligations. However, the federal and state laws provide a few exemptions to the sale of the debtor’s assets. The debtor may keep his own primary residence and other personal belongings.
Upon liquidation, the trustee acts as the administrator and gives partial payment to some creditors from the proceeds of the money raised from selling of the assets. After liquidation, it is not surprising that many creditors will not be paid so these financial obligations from them are considered “forgiven”. Those who file for Chapter 7 cannot file again within seven years and the remaining debts from the previous filing will not be discharged in the succeeding filing.
Alimony, child support and taxes are among the payables that cannot be discharged under any bankruptcy filing. Even student loans are rarely forgiven in Chapter 7 bankruptcy.
Chapter 11 bankruptcy – Reorganization:
Organizations with heavy financial burdens often file for Chapter 11 bankruptcy. In Chapter 11, debtors propose a repayment plan for their debts as well as present a post-bankruptcy profitability plan such as searching for new sources of income and reduction of expenses. Once a debtor-company files for Chapter 11, the creditors are held at bay, and the company is protected from them for quite some time until the bankruptcy is approved and the repayment plan starts.
The debtor-company gets to keep his business, keeps creditors on hold, while preparing for the repayment plan of its debts. This is different with Chapter 7 because in Chapter 7, the debtor-company liquidates their assets to pay debts and start again after liquidation. For those who qualify for Chapter 11, they enjoy certain advantages as compared with the other types of bankruptcy filing.
Filing a petition for the Chapter 11 process
Once the debtor or the creditor has filed for Chapter 11 bankruptcy with the U.S. Bankruptcy Court, the debtor’s obligations and collections are put into automatic stay. No creditors and collections can pursue any collection activities for the unpaid debts because of the automatic stay issued by the court. During this time, the debtor drafts a reorganization plan to negotiate a more achievable repayment plan and the debtor ceases worrying about their payables.
Chapter 11 Reorganization plan
Chapter 7 bankruptcy is meant to dispose the debts and obligations of the debtor. Chapter 11, which is good for businesses, is meant to give chances to the debtor to repay debts and at the same time, remain profitable.
To start with the repayment plan, the debtor renegotiates leases and contracts which results to debts either being discharged or being paid lower than the original debt totals or establish a different payment plan. At this point, creditors may work with the debtor and compromise on the payment terms.
A payment reorganization plan classifies creditors into different classes depending on how their claims are handled. They are ranked according to the most priority to the least priority. First priority payables are the state and federal tax agencies, the owed salaries and the stockholder interests — these are put into the first priority class. Secured creditors belong to one class, unsecured claims in another class and so on and so forth. There may be modifications in the plan as to the amount and terms of payment. Creditors vote on the reorganization plan and the court approves it.
As long as the reorganization plan is done in good faith, is reasonable, and complies with the law, the court usually confirms it. Once confirmed, the debtor starts to repay creditors according to the plan.
Chapter 13 bankruptcy:
To some extent, Chapter 11 and Chapter 13 bankruptcy are similar as they both allow debtors to pursue business operations, propose a reorganization plan for their debts, and formulate a profitability plan for their business. The only difference between the two is that while many can be qualified to file for Chapter 11, not many businesses, especially the smaller ones, are eligible to file for Chapter 13.
Chapter 13 can be filed by individuals with a regular income. An owner of a sole proprietorship business can file a Chapter 13 petition for his business. Small businesses that are operating through partnerships and other entities do not qualify for Chapter 13.
Chapter 13 has debt limitations that are periodically changing. At one period of time, Chapter 13 may be allowed only for debtors who owe not more than $350,000 in unsecured debt and $1,100,00 in secured debt. This amount may change from time to time. It is always best to consult a BAR authorized bankruptcy attorney regarding changes and regulation in the law.
A trustee is always appointed in Chapter 13 and their role is relatively limited. The trustee reviews the plan and other documents, presents recommendations to the court on how the plan will proceed. The trustee is also responsible for gathering the collection plan payments and takes charge of distributing the proceeds to the creditors.
Depending on what suits your needs, eligibility and preferences, please take as much time as needed to weigh your options wisely.