Types of Bankruptcies Explained: Which (If Any) Fits You?

Types of bankruptcy

Contending with the process of a bankruptcy is an unfortunate but common financial issue for many people. And while bankruptcy cases have decreased in recent years, the official U.S. Courts website states over 540,000 cases were filed in 2020. 1 The website defines bankruptcy as a process of “dealing with debt problems of individuals and businesses; specifically, a case filed under one of the chapters of title 11 of the United States Code (the Bankruptcy Code).”2 People undergo this financial solution for a variety of reasons. One reason is back taxes. The official Internal Revenue Service website lists bankruptcy as an option, next to settling debt or asking for a payment plan, for settling taxes owed, especially if you own a business.3 However, there are more personal reasons why people file for bankruptcy. The American Bankruptcy Institute lists unemployment, medical bills, and divorce as three major personal reasons for filing.4

What bankruptcy process to take mostly depends on whether or not the debt is personal or business-related. In fact, the official U.S. Courts website list 6 types to choose from.5 Learn about the differences between them below.

Types of Personal Bankruptcies

Chapter 7

This form of bankruptcy is a personal type of debt management. Chapter 7 bankruptcy can erase many types of consumer debt such as credit card and medical bills. Many people saddled with consumer debt from department stores, bank loans, and other such debt may file for chapter 7 too.

With chapter 7 bankruptcy, unsecured debts are usually the only debts that will qualify. The Cornell Law School Legal Information Institute website describes unsecured debts as “debt that doesn’t give the creditor the right to take a particular item of property if the debtor doesn’t pay.” 6 This means debt that does not involve collateral. Debts that could involve collateral (i.e. back child support, unpaid taxes, financial court judgements, student loans) typically do not qualify for chapter 7 bankruptcy.

If considering chapter 7, here are some things to keep in mind:

  • The debtor must be an individual or business.
  • According to the U.S. Courts website, the debtor “cannot file under chapter 7 or any other chapter, however, if during the preceding 180 days a prior bankruptcy petition was dismissed due to the debtor’s willful failure to appear before the court or comply with orders of the court, or the debtor voluntarily dismissed the previous case after creditors sought relief from the bankruptcy court to recover property upon which they hold liens.” 7
  • The debtor will have to undergo a means test. The U.S. Department of Justice website states that the means test form determines the debtor’s income and expenses to the debt they owe. 8 Once the form is filled out, the debtor takes the form and other pertinent documentation to their city’s bankruptcy court.

Chapter 13

Chapter 13 bankruptcy allows individuals to pay off debtors with a 3-5 year payment plan arrangement, depending how much steady income they make. The U.S. Courts website details several reasons why debtors would file for chapter 13 bankruptcy: 9

  • Chapter 13 offers protection against liquidation, the most prominent being protection of debtors’ homes from foreclosure. 9
  • Debtors are able to expand payment plans for secure debts, other than mortgages. This could in turn lower their obligated payments to these debts. 9
  • Any cosigners the debtors have could have special protection as well. 9
  • Debtors make their payments to a chapter 13 trustee, usually a bankruptcy lawyer’s office, and not the creditor. This helps to immediately stop collection calls and letters to the debtor. 9

To be eligible for chapter 13 bankruptcy, a debtor or individual running an unincorporated business, is eligible as long as the individual’s unsecured debts are less than $394,725 and secured debts are less than $1,184,200.9 Like chapter 7 bankruptcy, a debtor cannot file for chapter 13 if he or she had a bankruptcy petition dismissed due to their failure to appear before the court or comply with orders of the court within 180 days prior to petition. 9 Lastly, a debtor seeking chapter 13 bankruptcy (or any bankruptcy approach) cannot do so “unless he or she has, within 180 days before filing, received credit counseling from an approved credit counseling agency.” 9

Types of Business Bankruptcies

Chapter 7

The chapter 7 bankruptcy process for an individual vise a business operates in a similar fashion but there are a few big differences.

According to the official U.S. Securities and Exchange Commission website, when a public business files for chapter 7, it stops “all operations and goes completely out of business.”10A bankruptcy trustee will be charged with controlling the business’s remaining assets, to include liquidating all properties and assets to pay off debt.

Now it is possible for the business to restructure itself in hopes of making it profitable again to pay down debt and avoid absolute liquidation altogether. 

That’s where a chapter 11 bankruptcy filing comes in.

Chapter 11

An official reorganization of a business in order to pay off debt is called a chapter 11 bankruptcy.

According to the U.S. Courts website, a debtor can still control the company and can even borrow more resources without the courts approval.11 The debtor brings the reorganization plan to the court with justification on how it will be profitable and creditors can vote to approve the plan or not. But the debtor must also file several other documents to the court, not just the reorganization plan. According to the U.S. Courts website, these documents are: 11

  • A list of all company assets and liabilities.
  • A list of all income and expenses.
  • A list of all executable contracts and unexpired leases.
  • A statement of all financial affairs (to include marriage status, previous bankruptcies, property purchases or sold, gifts, bank and money market balances, etc.)12

There is a key difference in how chapter 11 bankruptcy will work depending on the business makeup. For established corporations, chapter 11 “does not put the personal assets of the stockholders at risk other than the value of their investment in the company’s stock.”11 Basically, the personal finances of the debtor or shareholders are not affected; just their business assets. However, with sole-proprietorship businesses, there is no such protection. According to the U.S. Courts website, “bankruptcy case involving a sole proprietorship includes both the business and personal assets of the owners-debtors.”11  This means the court leading the bankruptcy proceedings can treat a business owner’s personal wealth as income to pay back creditors.

Chapter 12

Chapter 12 bankruptcy is intended for family farms and fishing businesses that are in need of financial solutions. According to the U.S Courts website, chapter 12 bankruptcy allows “financially distressed family farmers and fishermen to propose and carry out a plan to repay all or part of their debts.” 13

Similar to chapter 13 bankruptcy, chapter 12 filings allow these businesses to propose a payment plan to their creditors over a 3-5 year period to eliminate debt. The length of time allowed will depend on a few factors such as the debtor’s income, alimony, and child support.13

The U.S. Courts website states that in order to qualify for a chapter 12 filing the debtor must:

  • Have a farming or fishing business.
  • All debts from the business must not exceed $4,153,150 (for a farming business) or $1,924,550 (for a fishing business).13
  • If a family farmer, at least 50%, and if family fisherman at least 80%, of the total debts that are fixed in amount (exclusive of debt for the debtor’s home) must be related to the farming or commercial fishing operation.13
  • More than 50% of the gross income of the individual or the husband and wife for the preceding tax year (or, for family farmers only, for each of the 2nd and 3rd prior tax years) must have come from the farming or commercial fishing operation.13

If the debtor is a farm or fishing business that is a partnership or corporation, there may be additional criteria to met if seeking a chapter 12 bankruptcy.

Other Types of Bankruptcies

Chapter 9

A more uncommon type of bankruptcy involves municipalities. 

According to the Cambridge Dictionary website, a municipality is a city or town that has its own government.14 It is separate from a sovereign state.

So, who can file for bankruptcy for an entire city? The U.S. Courts websites states that “the municipality must be specifically authorized to be a debtor by state law or by a governmental officer or organization empowered by State law.”15 So, while a municipality is legally established as its own government and an municipal official can file, state law determines if it qualifies a debtor or not.

While chapter 9 bankruptcy works similar to the other types of bankruptcies described, the major difference with a chapter 9 filing is that the state cannot liquidate a municipality’s assets to settle debt. Such a move would be a violation of the Tenth Amendment.15

Chapter 15

Chapter 15 bankruptcy is quite new, only being enacted into law back in 2005, per the U.S. Courts website.16

Debtors use chapter 15 bankruptcy when the debt reconciliation is “dealing with insolvency cases involving debtors, assets, claimants, and other parties of interest involving more than one country.”16 It was designed more so for foreign nationals to file for bankruptcy if they have assets in other parts of the world, including the U.S.

Chapter 15 bankruptcies are usually in addition to a primary bankruptcy proceeding in the debtor’s home country.

What To Do If Considering Bankruptcy?

Bankruptcy can be a trying time for any individual or business. Here are a few tips to considering before determining a bankruptcy plan:

  • Get familiar with each type of bankruptcy chapter to determine the best fit for the debtor’s needs.
  • Consider other options such a debt consolidation company or taking a loan from the debtor’s savings or retirement plans.
  • Call creditors and try to settle debt amounts, especially for consumer debt like credit cards. 
  • Prepare for potential massive hit from to all three credit bureaus. And expect for the bankruptcy filing to stay on a credit report for several years.
  • Treat bankruptcy as a last resort. Bankruptcy is a financial expense itself and can be a lengthy and very costly process.

Resources:

1 Unknown. (2021, January 28). Annual Bankruptcy Filings Fall 29.7 Percent. [Article].  Retrieved from https://www.uscourts.gov/news/2021/01/28/annual-bankruptcy-filings-fall-297-percent

2 Unknown. (no date). Bankruptcy Basics Glossary. [Webpage]. Retrieved from  https://www.uscourts.gov/educational-resources/educational-activities/bankruptcy-basics-glossary#content-for-b 

3 Unknown. (2021, May 11). Bankruptcy. [Article]. Retrieved from https://www.irs.gov/businesses/small-businesses-self-employed/declaring-bankruptcy  

4 Unknown. (no date). The 3 Most Common Reasons Why People File Bankruptcy. [Blog post]. Retrieved from https://www.abi.org/feed-item/the-3-most-common-reasons-why-people-file-bankruptcy 

5 Unknown. (no date). Bankruptcy. [Article]. Retrieved from https://www.uscourts.gov/services-forms/bankruptcy  

6 Unknown. (no date). Unsecured debt. [Webpage]. Retrieved from https://www.law.cornell.edu/wex/unsecured_debt

7 Unknown. (no date). Chapter 7 Bankruptcy Basics. [Article]. Retrieved from  https://www.uscourts.gov/services-forms/bankruptcy/bankruptcy-basics/chapter-7-bankruptcy-basics

8 Unknown. (2021, April 30). Means Testing. [Article]. Retrieved from 

https://www.justice.gov/ust/means-testing

9 Unknown. (no date). Chapter 13 – Bankruptcy Basics. [Article]. Retrieved from https://www.uscourts.gov/services-forms/bankruptcy/bankruptcy-basics/chapter-13-bankruptcy-basics

10 Unknown. (2009, February 3). Bankruptcy: What Happens When Public Companies Go Bankrupt. [Article]. Retrieved from https://www.sec.gov/reportspubs/investor-publications/investorpubsbankrupthtm.html     

11 Unknown. (no date). Chapter 11 – Bankruptcy Basics. [Article]. Retrieved from https://www.uscourts.gov/services-forms/bankruptcy/bankruptcy-basics/chapter-11-bankruptcy-basics  

12 Unknown. (no date). Official Form 107 – Statement of Financial Affairs for Individuals Filing For Bankruptcy. [Form]. Retrieved from https://www.uscourts.gov/sites/default/files/form_b_107.pdf 

13 Unknown. (no date). Chapter 12 – Bankruptcy Basics. [Article]. Retrieved from https://www.uscourts.gov/services-forms/bankruptcy/bankruptcy-basics/chapter-12-bankruptcy-basics  

14 Unknown. (no date). Municipality. [Webpage]. Retrieved from https://dictionary.cambridge.org/us/dictionary/english/municipality

15 Unknown. (no date).  Chapter 9 – Bankruptcy Basics. [Article]. Retrieved from https://www.uscourts.gov/services-forms/bankruptcy/bankruptcy-basics/chapter-9-bankruptcy-basics 

16 Unknown. (no date). Chapter 15 – Bankruptcy Basics. [Article]. Retrieved from https://www.uscourts.gov/services-forms/bankruptcy/bankruptcy-basics/chapter-15-bankruptcy-basics