Bankruptcy Basics
The information contained below is intended to give general information on the differences and uses of each bankruptcy chapter. It is not intended as legal advice. The final outcome of any particular case will depend upon the specific and unique facts contained therein.
There are five different chapter bankruptcies that can be filed. We will not discuss Chapter 9 (railroads and municipalities) or Chapter 15 (cross boarder insolvencies) as those Chapters are beyond the scope of this web site.
Chapter 7
This form of bankruptcy allows individuals to obtain a “fresh start” by agreeing to surrender nonexempt property to a trustee for the benefit of creditors. Once the case is filed, a court appointed trustee begins the process of determining if there are assets that can be liquidated for the benefit of creditors. The proceeds are then used to pay those creditors based upon the ranking a particular creditor has. The Bankruptcy Code establishes that ranking and creditors at the top of the chain will be paid in full (if there are sufficient proceeds) before creditors next in line. Creditors of the same ranking will be paid on a pro rata basis. This allows for an orderly distribution of the proceeds of the bankruptcy estate. Creditors who choose not to participate in the potential distribution simply will not receive any funds. Any amounts not paid by the trustee will be subject to the entry of the debtor’s discharge unless the particular claim is deemed by law to be non-dischargeable.
In a Chapter 7, only individuals can obtain a discharge. Certain debts are not subject to the entry of a general discharge. This includes, but is not limited to, any obligation arising from a domestic relations matter, certain taxes owed to the various taxing agencies, student loans and, if a timely objection to the discharge is filed and a creditor proves its case, claims arising from fraud, misrepresentation, willful and malicious injury, and breach of fiduciary duty. This Chapter may be a good choice if you do not own much property and the property you do own can be protected by the use of exemptions. It is also a good choice if you do not otherwise need to reorganize to protect a home, a car, non-exempt property or pay taxes or domestic support obligations. A Chapter 7, assuming there are no bumps along the way, will take between four and six months to complete.
Chapter 11
This form of bankruptcy allows either an individual or business (corporation or limited liability company) to reorganize. The debtor normally remains in control of his/her/its assets and/or business and proposes a plan of reorganization which allows creditors to be paid over time. The amount paid to such creditors and the length of time for such payments will be based upon many factors including the value of the debtor’s assets, the debtor’s ability to pay and what, under law, is required to pay. The funding of the plan of reorganization can come from an individual’s earned income, a business’s profits or the liquidation of assets, or, even a combination of all. There is much flexibility in how and when creditors are paid.
The debtor takes on the role of the court appointed trustee and has all of the duties and responsibilities of the trustee. The debtor becomes a fiduciary to the creditors and must show the court that he/she/it is using his/her/its best business judgment in preparing and implementing the plan of reorganization. Creditors are given the opportunity to vote on the plan of reorganization and numerous factors determine if that vote can be overcome by the debtor should creditors disapprove.
Chapter 12
This form of bankruptcy is a reorganization limited to those who qualify under the Bankruptcy Code. The debtor remains in possession of all property and, if qualified, can use this Chapter as a strong tool to modify the rights of creditors. Chapter 12 has more flexibility than a Chapter 11 or even a Chapter 13 (see below). To qualify, one must be a “family farmer or fisherman” and have regular annual income which may be seasonal as long as it is stable and produces enough revenues to effectuate the plan of reorganization. The debtor proposes a plan of reorganization and once approved by the Court will make payments to a Trustee who then pays the creditor based upon the terms of the order approving the plan.
While creditors have the ability to object to their treatment under the plan, creditors are not permitted to vote on the plan. If an objection is filed the debtor will have to work to resolve the objection or let the Court decide if the objection is justified.
Chapter 13
This form of bankruptcy is used by individuals to provide a way to repay certain obligations in an effort to save homes, cars, pay taxes, pay child support or to simply keep non exempt property instead of turning that property over to a Chapter 7 trustee. To qualify for a Chapter 13 the individual (or married couple) must have “regular income”. There are debt limits in this Chapter. Effective April 1, 2022, a debtor cannot have secured debt that exceeds $1,395,875.00 and/or unsecured debt that exceeds $465,275.00. If a debtor exceeds the debt limits of a Chapter 13 and wishes to “reorganize”, he/she will need to consider a Chapter 11. If a debtor qualifies for a Chapter 13, he/she will propose a plan of reorganization that will pay creditors, as required by law, over a three to five year period by making monthly payments to the Chapter 13 trustee. The amount of the monthly payment will depend upon many factors including a debtor's ability to pay and what creditors need to be paid over the three to five years. Payments are made to a Trustee and, like the Chapter 12 (above), the Trustee distributes the payments to creditors pursuant to the court approved plan.
Creditors can object to the plan but cannot vote and any objection must be resolved either through negotiation or by a determination by the court.