When businesses and individuals file for bankruptcy, what they might not know is that there are different kinds of bankruptcy filings from which to choose. The two most commonly known types of bankruptcy for individuals are Chapter 7 and Chapter 13. Businesses filing for bankruptcy have two other options, which are Chapter 11 and Chapter 12. In order to choose the right bankruptcy filing, businesses and individuals first have to understand each type of filing and to whom the filing applies.
When a business or individual files for Chapter 7 bankruptcy, the assets are immediately liquidated in order to raise any cash that can be used to pay off the debts. Real property, such as real estate, is considered an asset. Other assets include personal property, such as cash, household goods, retirement accounts and furniture.
Debts that can be discharged in a bankruptcy include some types of taxes, auto loans, home mortgages and credit cards. A trustee, the person responsible for liquidating the assets, is assigned to a Chapter 7 bankruptcy filing. In some states, such as North Carolina and Alabama, a bankruptcy administrator acts as a trustee. Once the assets are liquidated, debtors can then stake claim to what they are owed. The cash is distributed among the debtors.
A business or individual that does not see a financial future is the one that benefits the most from filing for Chapter 7 bankruptcy. Filing for this type of bankruptcy provides a clean slate or fresh financial start. If the business or individual does not have any foreseeable income in the future, this type of bankruptcy can be the most beneficial.
Some types of debts are not discharged or extinguished under Chapter 7 bankruptcy. These types of debts include, but are not limited to:
- Federal debts
- Mortgage loans
- Student loans
- Personal injury debts (for vehicle accidents as an example)
- Fines or penalties owed to government agencies
When an individual or business files for any type of bankruptcy, the bankruptcy remains on the credit report for a period of up to 10 years. Individual consumers and businesses have the option for rebuilding credit ratings after a bankruptcy and eventually the bankruptcy does fall off the credit report.
Some states allow bankruptcy filers to exempt some of their assets from liquidation. For example, the state of Mississippi permits an individual to keep up to $10,000 of personal property and the individual's primary home with a market value up to $75,000. Florida allows filers to exempt their primary home, the cash surrender value of life insurance policies and annuities from the liquidation process. Find out about your state's rules before filing.
A Chapter 11 bankruptcy is generally for a business that is looking to restructure its debt. Restructuring debt involves altering the initial terms the debtor had with the creditor. For Chapter 11 bankruptcy, this typically means changing the balance owed to the creditor, so that the creditors receive a partial payment of the debt. For example, if a credit card balance is $100,000, the credit card issuer can agree to accept an $85,000 payoff. The creditor then discharges or forgives the rest of the debt, $15,000.
An individual can also file for Chapter 11, which for individuals works similar to that of Chapter 13. For example, assets include any of the debtor's income and any property the debtor acquires after filing for bankruptcy and up until the bankruptcy case is closed. The bankruptcy court can garnish future earnings to pay the creditors.
Filing for Chapter 13 bankruptcy requires the consumer or the business to restructure debt, which is different from Chapter 7 where the debt is discharged. For Chapter 13 filings, restructuring the debt involves altering the original terms of the agreement, such as changing the monthly payment amounts or lowering the interest rate to make the repayment of the debt more affordable to the debtor. The individual or business debtor works with the bankruptcy court to come up with a repayment plan that is affordable.
In general, the repayment period runs from three to five years, so the remaining balance has to be paid off during this time.
An individual or business that has a regular income, but needs to reduce the amount of debt to a manageable level primarily benefits from Chapter 13 bankruptcy. Filing for this type of bankruptcy allows debtors to take responsibility for repaying debt but at a reduced amount.
Chapter 12 bankruptcy is similar to filing for Chapter 13 bankruptcy. The only difference is that Chapter 12 bankruptcy is available for family-owned and operated farms. Because this type of bankruptcy has specific considerations for the seasonal variances in agricultural businesses, families can continue to operate their farms while restructuring their debt during the bankruptcy process.
A family farmer that has income, but needs to reduce the amount of debt to a manageable level, primarily benefits from Chapter 12 bankruptcy. Filing for this type of bankruptcy allows the farmer to take responsibility for repaying debt but at a reduced amount so they can afford the repayment.
Seek Professional Guidance
Prior to filing for bankruptcy, an individual or business has to learn about the different types of bankruptcy filings available. Learning how each bankruptcy filing works and the benefits of each is the key element to choosing the right type of bankruptcy. For more information, speak to a bankruptcy professional.