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Everything You Need to Know About Filing for Bankruptcy: Chapters 7, 11, and 13 Explained

November 2017

In 2016, 794,960 debtors sought debt relief through the bankruptcy courts. Although it sounds like a lot, that number pales in comparison to the peak period of 2010, which saw nearly double the number of filings. In the last six years, the number of bankruptcy filings has fallen by around 40%.

While it’s encouraging that bankruptcy rates are falling, the number of filings logged nationwide indicates that a significant number of debtors still need to access the “fresh start” afforded by the bankruptcy laws. The three methods of achieving this are variously referred to as Chapters 7, 11 and 13 bankruptcy, with each number referring to the chapters of the bankruptcy code under which a case may be filed.

It’s important to understand the difference between these three types of bankruptcy. Here’s what you need to know.

Chapter 7 Bankruptcy

Under Chapter 7, most debtors wipe out their unsecured debt entirely by selling their assets and divvying the funds among creditors. Unsecured debt includes credit cards and medical bills that have no collateral for the loan.

In every state, there are exemptions – property you are allowed to keep such as a retirement plan or inexpensive car; but the bankruptcy trustee will liquidate everything else. Chapter 7 means the end of the line for corporate debtors, however. The trustee will sell all the business assets and shut the business down.

Who qualifies? Businesses and individuals who live, have a place of business or own property in the United States can file for Chapter 7. There’s no qualifying amount of debt, but you’ll have to pass an income test. Essentially, you may want to consider a Chapter 7 bankruptcy if there is no hope of repaying any of your debts.

Advantages:

  • It’s the fastest and cheapest form of bankruptcy, with average cases lasting three to six months from filing to discharge.
  • Over 95 percent of individuals who file for Chapter 7 do not own any non-exempt property and therefore don’t have to surrender any assets.

Disadvantages:

  • Child support, student loans, school loans and some other debts are not eliminated by Chapter 7. If you have these debts, Chapter 13 may be a better option.
  • Chapter 7 does not remove your lender’s right to foreclose on its mortgage loan. You must continue to pay your mortgage if you want to keep your home.

Chapter 11 Bankruptcy

Chapter 11 allows a struggling business an amount of time free of collection activity, so it can restructure its financial obligations and emerge in a better state of health. Creditors (acting by committee) vote on the reorganization plan and the plan must be approved by the bankruptcy court.

The advantage of chapter 11 is that the business maintains control of its assets and is allowed time to negotiate a plan of repayment. On the downside, just 10 to 15% of Chapter 11 filings result in successful reorganizations. Most cases are dismissed or converted to Chapter 7 liquidations by the company’s creditors.

Who qualifies? Chapter 11 is most often used by corporations, partnerships and limited liability companies, but it can also help individuals who have too much debt or income to qualify for Chapter 7 or 13.

Advantages:

  • Chapter 11 saves the business name, goodwill and customer base.
  • Businesses may be able to cherry-pick the leases and contracts they wish to maintain, surrender those that are not economically profitable and emerge with a reduced debt load.

Disadvantages:

  • Chapter 11 is the most expensive form of bankruptcy due to the higher filing fees and cost of the legal work involved.
  • Debtors are subject to stringent financial record keeping and reporting requirements which can be extremely burdensome.

Chapter 13 Bankruptcy

Chapter 13 bankruptcy allows individual debtors with a regular income to pay off all or part of their debt over a period of three to five years. A trustee will work out a repayment plan calibrated to your income and distribute monies to creditors. As long as you make the plan payments, you get to keep all the property you already own.

After completion of the plan, the plan debts are wiped out. Even if your plan only provides for payment of 20% of the debt, then the remaining 80% will be discharged. However, most long-term debt such as home mortgages will survive after the bankruptcy is closed. You can cure defaults through the plan but on completion, the mortgage will be current and regular payments will continue.

Who qualifies? Individuals who can afford to pay some but not all of their debt qualify for Chapter 13. To be eligible, your secured debts must be less than $1,184,200 and unsecured debts less than $394,725. You must have enough income to make a reorganization plan feasible.

Advantages:

  • Filing for Chapter 13 stops foreclosure and may allow you to keep your home while you clear the past due mortgage debt in bankruptcy.
  • Second and third mortgages can be removed or stripped by the bankruptcy court if you’re underwater with your first loan.

Disadvantages:

  • Three to five years is a long time! During this period, you must commit all your disposable income to paying back creditors.
  • Only 40% of Chapter 13 cases end in full discharge of debts compared to 96% of Chapter 7 bankruptcies.

Don’t Go It Alone

No two bankruptcy cases are the same, and it’s not always obvious which type would be best for your situation. Goldin Peiser & Peiser LLP has significant experience working with bankruptcy counsel and debtors. Our professionals are familiar with bankruptcy discharge issues – specifically, taxes. We are uniquely qualified to assist with IRS transcript analysis and the identification and valuation of assets and liabilities. Contact us today!

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