Declaring bankruptcy is not as simple as just telling the court that you can’t pay your bills. Bankruptcy is a complex legal status with nuances that, at first glance, can seem overwhelming and confusing.
The different “chapters” of bankruptcy can be especially confusing. Unless you have a legal or financial background, chances are good that you don’t know the first thing about the differences between Chapter 7, Chapter 11, and Chapter 13 bankruptcies.
Chapter 11 can be especially confusing. They are for individuals and are far less common and far more misunderstood than Chapters 7 and 13. Could a Chapter 11 filing be right for you? We’ll break it down below.
Before you dive into the specifics of Chapter 11, you need a firm grasp on bankruptcy as a concept.
When a business (or individual) declares bankruptcy, it is declaring to the courts that it can no longer afford to pay back debts as they currently stand. Bankruptcy provides a legal structure for paying back some of the debts (but likely not all of them), while also protecting the debtor from being sued or harassed for repayment by creditors.
Bankruptcy is not a quick or easy way out of debt, however. During bankruptcy, your personal information is open for the court to see as it evaluates your debts and assets. Depending on the type of bankruptcy you file, you could lose your home and many of your assets. Your credit could also take a lasting hit, as bankruptcy remains on your credit report for many years after the initial filing. In short, while bankruptcy can be a godsend for debtors with nowhere else to turn, it’s more of a last resort.
Chapter 7 vs. Chapter 11 vs. Chapter 13
Now that you understand the basic idea behind bankruptcy, let’s dive into the specifics. What are the differences between Chapter 7, Chapter 11, and Chapter 13 bankruptcies, and how do you know which is right for you?
Chapter 7 bankruptcy
Chapter 7 bankruptcies are among the most common types of bankruptcies and likely the closest to what you imagine when you think “bankruptcy.”
In a Chapter 7 bankruptcy, you liquidate your assets in order to pay back your debts. Liquidating your assets allows you to raise funds to pay back your debts quickly. You don’t have to raise the full repayment amount by liquidating your assets; in a Chapter 7, your creditors have to take what they can get.
Not all your assets will be up for liquidation. While the list of “exempt” properties varies from state to state, you may generally keep your car, your clothing, your furniture, and other assets considered necessary for maintaining a life. After all, the point of bankruptcy is to eliminate your debts, not put you out on the street.
Only individuals with little to no income will qualify for Chapter 7 bankruptcy. If you make too much money or have too much disposable income, you’ll probably have to file for Chapter 11 or Chapter 13.
Chapter 13 bankruptcy
After Chapter 7, Chapter 13 bankruptcies are generally the most common type of filing for individuals. In a Chapter 13 filing, you restructure your debts to make them more manageable. You get to keep your assets unless you choose to sell them off yourself.
Usually, the repayment period for a Chapter 13 filing is between three and five years. During that time, you will make fixed payments on qualifying debt as determined by the bankruptcy court. At the end of the repayment period, any remaining debt will be gone.
Not all debt qualifies for Chapter 13, though. If any of your debts fall outside the jurisdiction of a Chapter 13 filing, you’ll have to deal with them separately.
If you make too much money to qualify for Chapter 7 bankruptcy protection, you’ll likely file for Chapter 13 instead. The process takes longer, but it does allow you to keep your assets.
Chapter 11 bankruptcy
In a Chapter 11 bankruptcy, you reorganize your debts so that you can afford to pay them. No liquidation of assets is necessary. You retain position of all your assets and stay in control of the bankruptcy process as it proceeds.
Chapter 11 bankruptcies are notable in a few aspects. Unlike Chapter 7 or Chapter 13, there are no income limits and no set time limits for a Chapter 11 filing. Due to this level of flexibility, as well as other nuances of the law, Chapter 11 filings are by far the most complex of the filings we’ll cover in this article.
Because of this flexibility and complexity, most individuals do not file for Chapter 11 unless their income is so high that they do not qualify for Chapter 13 bankruptcy protection. That’s why you generally see businesses, not individuals, filing for Chapter 11. Common exceptions include high net worth individuals such as celebrities, as well as married couples whose combined income exceeds the limits of a Chapter 13 filing.
Why file for Chapter 11 bankruptcy?
As we’ve already mentioned, an individual filing for Chapter 11 bankruptcy is uncommon. Most private individuals file for Chapter 7 if they have low to no income, and Chapter 13 otherwise. Chapter 11 is generally reserved for businesses and corporations; so, why would you file for Chapter 11?
You don’t qualify for a Chapter 13 bankruptcy
The main reason that individuals file for Chapter 11 is that they don’t qualify for Chapter 7 or Chapter 13. Their income may be too high or their debts may exceed the limits for those types of filings. At the time of writing, Chapter 13 debt limits are $394,724 for unsecured debts and $1,184,200 for secured debts. There’s no limit for Chapter 11 filings.
While most individuals won’t amass those kinds of debts in their lifetimes, wealthier individuals with more access to debt and credit might. Because of this, you see many celebrities and professional athletes filing for Chapter 11 over Chapter 13.
You need to stretch out your mortgage repayment period
The prospect of losing your home in a bankruptcy filing can be terrifying. In a Chapter 7 bankruptcy, there’s a chance that you might lose your primary residence, especially if you’re behind on mortgage payments.
In a Chapter 13 filing, it’s less likely that you’ll lose your home, but still possible. Chapter 13 bankruptcies come with the stipulation that you must pay off your mortgage arrears totally within five years. If you’ve only missed a few mortgage payments, catching up on your mortgage might be no big deal. If you’re a year or more behind, though, then paying off your arrears with your current income can be almost impossible within the allotted period.
With a Chapter 11 bankruptcy, though, there is no set time limit on your repayment period. This level of flexibility can make filing and managing a Chapter 11 bankruptcy more complex, but it can also allow you to stretch out your repayment period long enough that you can catch up on your mortgage and avoid losing your home.
You own a “910” car
One of the biggest draws of filing for bankruptcy is that your filing can immediately cut down on the amount of debt you owe.
For instance, in bankruptcy, the liens your creditors have on your property reduce to fair market value. Say you bought a nice new car and paid $33,000 for it. Some time passes and you’re struggling with your debts, so you file for bankruptcy. Among other things, you still owe $30,000 for the car.
The bankruptcy court finds that the car itself is actually only worth $20,000 at a fair market value. Instead of forcing you to pay back the full $30,000 balance, it only puts you on the hook for the $20,000, immediately saving you $10,000.
There’s a catch, though. In Chapter 13 bankruptcies, there’s a provision that states that any car financed within 910 days of your filing cannot be “crammed down” to its fair market value. The car is now only worth $20,000, but you’re still on the hook for the full $30,000.
With Chapter 11 bankruptcies, no such stipulation exists. If you can prove that your car is only worth $20,000, then that’s all you’ll have to pay over the course of your bankruptcy process, no matter when you secured financing.
Even though this might represent a significant savings to you, you should weigh the costs of choosing a Chapter 11 bankruptcy over Chapter 13. The added complexity might lead to increased lawyer fees and other costs that could negate your “910” car savings.
You filed for Chapter 7 or Chapter 13 too recently
You can’t file for bankruptcy every time you can’t pay your bills. The law limits how often an individual can file for different types of bankruptcies. If your debt discharged via Chapter 7 within four years of your new filing, or if it discharged via Chapter 13 within two years of your new filing, then you are ineligible to file for Chapter 13.
Chapter 11 bankruptcies do not have the same limits. It doesn’t matter if you just received a Chapter 7 or Chapter 13 discharge; as long as you’ve made your payments under the previous plan, you’re eligible to file again for Chapter 11.
You’re also struggling with many non-dischargeable debts
Not all debts are eligible for discharge through bankruptcy. For businesses, payroll taxes represent a huge source of potential debt that a bankruptcy cannot wipe out. For individuals, the biggest sources of non-dischargeable debts are usually student loans, child support, alimony, and income tax liabilities.
Since these debts are non-dischargeable, bankruptcy courts cannot put a stay on the penalties and harassment that can result from non-repayment. Even while you’re struggling to keep up with your bankruptcy repayment plan, these debts will continue to accrue extra fees and grow until dealt with.
Only a Chapter 11 bankruptcy has provisions to help individuals and businesses deal with these non-dischargeable debts. While a Chapter 11 filing won’t eliminate these debts, it may be able to stop the non-repayment fees from accruing, especially in the case of taxes. This arrangement might give you a little extra breathing room so you or your attorney can work out a repayment plan with your creditors (or the IRS) outside of the bankruptcy process.
The bottom line
Here’s the main takeaway: more often than not, Chapter 11 bankruptcy is not the right decision for an individual to make. Chapter 7 is usually right for people with low to no disposable income, allowing those individuals to liquidate their assets, discharge their qualifying debts, and start fresh.
If an individual is too wealthy to qualify for Chapter 7, he or she will generally want to file for Chapter 13 bankruptcy. Chapter 13 allows an individual to restructure qualifying debts and develop a manageable repayment plan that will enable that individual to discharge debts within three to five years.
Chapter 11 bankruptcy also allows a debtor to restructure debts and devise a repayment plan that works. However, a Chapter 11 filing is much less restructured than a Chapter 13 filing. There is no income limit and no time limit. The debtor will likely have to pay a premium to have an experienced attorney put together a process. For most people, it’s not worth it.
That said; Chapter 11 might make sense for an individual. If you have too much debt to qualify for a Chapter 13 filing, are at risk of losing your home or your car, or need special protections from the penalties associated with certain non-dischargeable debts, then Chapter 11 might make sense, but you’ll definitely want to consult with a professional before you make that decision.