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5 Types Of Bankruptcy And How They Work



Types of Bankruptcy


Debt can be a major burden, particularly if it adversely affects your livelihood. In such cases, you may want to consider bankruptcy as an option.

The U.S. Bankruptcy Code includes five different types of bankruptcy, each designed for a specific type of debtor. The goal of each chapter is either liquidation (i.e. using certain assets to repay creditors) or restructuring (i.e. creating a payment plan to pay off all or part of the debt owed).

Bankruptcy is a legal process that allows people or businesses to restructure their debts. There are several types of bankruptcy, but the two most common are Chapters 7 and 13. Individuals typically file for one of these types, while businesses may file for either depending on their needs. Here’s what you need to know about each option.

Chapter 7

Individuals or businesses who are struggling with debt can opt for bankruptcy. In a liquidation bankruptcy, also known as a “fresh start” bankruptcy, debtors can give up nonexempt assets and walk away from most debts. To qualify, debtors must pass the means test – their income must be less than their state’s median income.

Not all debt can be discharged in a liquidation bankruptcy. However, for eligible debts that are discharged, individuals are no longer liable for them.

Who this is best for: Only those who can pass the means test are eligible.

What happens to the debt: The debt is discharged.

Primary advantage: The process is relatively quick.

Primary disadvantage: Debtors who file for Chapter 7 may find that they lose some of their non-exempt assets.

Chapter 9

Municipalities can use Chapter 9 bankruptcy to reorganize their debt. By doing so, they can create a plan to get out of financial hardship without having to sell their assets.

Cities and towns that declare bankruptcy under Chapter 9 of the U.S. Bankruptcy Code can reorganize their debts by lowering the interest rate, reducing the principal amount, extending the repayment term, or refinancing.

Who this is best for: Municipalities that are in financial distress.

What happens to the debt: The debt is reorganized.

Primary advantage: The filing petition by a municipality has the effect of an automatic stay.

Primary disadvantage: It’s costly and can be hard to get approved.

Chapter 11

Chapter 11 bankruptcy is a process through which individuals and businesses can restructure their debt. This type of bankruptcy allows the filer to create a plan to repay some of the debt while still retaining assets.

Chapter 11 is more complicated and expensive than other types of bankruptcy, making it feasible mainly for businesses and wealthy individuals. When a corporation files for Chapter 11, shareholders’ assets are not at risk since the business is considered a separate entity from its owners. However, in a sole proprietorship, the owner and debtor are the same people, so both personal and business assets are considered in a Chapter 11 bankruptcy filing.

Who this is best for: Corporations or business partnerships.

What happens to the debt: The debt is reorganized.

Primary advantage: As a business owner, you may be wondering what will happen to your company should you file for bankruptcy.

Primary disadvantage: It’s costly and can be time-extensive.

Chapter 12

Farmers and fishermen who have regular income can reorganize their debt under Chapter 12 of the bankruptcy code. This option is more advantageous than the similar provisions under 13 for farmers with larger debts and does not require that the farmer meet the wage-earner classifications set out in that section. Repayment usually stretches out over three years, but a court can also decide to extend the repayment period up to five years.

Certain debts, like child support or alimony, are not dischargeable through this type of bankruptcy. However, after the debtor fulfills all payments in the reorganization plan, the other debt is discharged.

Who this is best for: Family farmers or family fishermen.

What happens to the debt: The debts are repaid with a repayment plan.

Primary advantage: Can repay the debt over a maximum of five years.

Primary disadvantage: Chapter 7 may not be the best option for some creditors, and chapter 11 may be too complicated for some businesses. A simpler process might be more favorable in these cases.

Chapter 13

Bankruptcy can be a complicated and daunting process, but Chapter 13 may be a good option for those who need to restructure their debt. Under this type of bankruptcy, some creditors will be paid back in full with interest, while others will receive a percentage of the debt. The repayment period is typically three to five years.

To be eligible for Chapter 13 bankruptcy, debtors must have regular income and their debts must meet certain thresholds. Unsecured debt must be less than $394,725 and secured debts must be less than $1,184,200. One advantage of Chapter 13 is that the debtor’s home is not at risk of foreclosure during these proceedings.

Who this is best for: Individuals with regular income

What happens to the debt: The debts are repaid with a repayment plan.

Primary advantage: Can keep home from going into foreclosure.

Primary disadvantage: Repayment plans can take up to five years.

If You Have Too Much Debt, What Should You Do?

Editorial Credit: Vitaliy Abbasov

Debt can be overwhelming, but there are options available to help you get back on track.

  • Negotiating directly with creditors. Debtors should be transparent about their financial situation and try to work out a payment plan with their creditors. This will increase the chances of getting at least some of the money that is owed, as opposed to getting nothing in the case of a Chapter 7 bankruptcy.
  • Credit counseling. There are several things you can do to get your finances back on track. A good place to start is with a nonprofit credit counseling agency. They can help you create a debt management plan and stop collection calls. For more information, visit the National Foundation for Credit Counseling website.
  • Bankruptcy. Bankruptcy is a last resort option for people who have tried everything else to address their debt. This path has severe consequences for your credit record and can adversely affect your credit for up to 10 years.

Final Thoughts

Bankruptcy is not something to be taken lightly. It’s a complicated process, so you should consult with a knowledgeable attorney before making any decisions. Regardless of which chapter you file, you’re required to receive credit counseling from an approved agency within 180 days of filing.

Before deciding to file for bankruptcy, it is important to consult with a credit professional. This option may not discharge all of your debt, so it is important to understand the implications before moving forward.

Kareem was born in Tunisia, and he has always had a passion for politics. He is an economist, and he has run for office three times. He is currently in his third marriage, and he has four children. His passion is waterskiing; he loves to ski on the open water.

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