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There are five different types (“chapters”) of bankruptcy protection offered by the government via the Bankruptcy Code. The eligibility requirements for each chapter are different and while some may qualify under multiple chapters, many may only qualify under one. Declaring bankruptcy is a method for individuals, corporations/businesses, and even municipalities to request the federal government’s assistance in alleviating debt.
You may qualify if your current monthly income exceeds the state median and you pass the “means test,” which compares your income to expenses. The means test is only applied to debtors with mostly consumer, rather than business, debts. The total amount of your debt is not a factor in determining eligibility.
One of the two most common forms of individual bankruptcy is a Chapter 7 bankruptcy filing. This chapter of the Bankruptcy Code is commonly referred to as “liquidation bankruptcy.” In a Chapter 7 bankruptcy, the court will assign a trustee who liquidates (sells off) a debtor’s non-exempt assets to repay creditors. As a general rule, assets essential to modern life are usually exempt from bankruptcy proceedings. Those individuals with too much income may not qualify to file for Chapter 7 and will likely have to file for bankruptcy under Chapter 13.
Unlike Chapter 13, there is no debt limit for a Chapter 7 bankruptcy filing. Anyone with mostly consumer debt and making more than their state’s median monthly income must take a “means test.” In the 180 days prior to filing for Chapter 7 bankruptcy, individuals (but not businesses) must have completed mandatory credit counseling through an approved credit counseling agency.
On average, a Chapter 7 bankruptcy lasts about six months. Once the proceeds from your liquidated assets have been portioned off to your creditors, the court will issue you a discharge of your qualifying debts. The discharge is the end of the bankruptcy process and absolves you of all further personal liability for any debts that are dischargeable. This means creditors/debt collectors may no longer attempt to collect on any discharged debt. Not all debts are dischargeable via bankruptcy. Some common examples of non-dischargeable debts include alimony payments, child support, student loans, and criminal restitution.
Debtors who attempted to file for Chapter 7, but failed the “means test,” are usually eligible to file for Chapter 13. To qualify for Chapter 13, a debtor must have less than a certain amount of secured and unsecured debt. The debt limits fluctuate based on changes in the consumer price index. Only individuals may file for Chapter 13; this form of relief is not available to businesses or municipalities.
Chapter 13 bankruptcy is available to those who earn too much to qualify for Chapter 7. Instead of discharging a debtor’s debts through liquidation of assets, the court will require you to propose a repayment plan. You will make regular payments to creditors over three to five years. Chapter 13 is particularly attractive to homeowners because it can save their homes from foreclosure. Foreclosure proceedings are stopped by the bankruptcy court’s “automatic stay.” The means test is not required for those who file for bankruptcy under Chapter 13.
Chapter 13 debtors file their proposed plan of repayment with the court. The court will then hold a confirmation hearing. The repayment plan may be approved if:
Creditors can file objections to the debtor’s proposed plan prior to the confirmation hearing. Once the plan has been confirmed by the judge, the debtor will need to make regular, scheduled payments to the trustee over the course of the three to five year plan. The trustee disperses the payments to creditors.
After satisfactory completion of the repayment plan, the court will discharge the debtor’s qualifying debts. Chapter 13 bankruptcy will stay on your credit report for up to seven years. Chapter 7 bankruptcy may stay on your credit report for up to ten years.
The goal of a Chapter 11 bankruptcy is to give a business a lifeline so it can return to profitability. Corporations like Kmart, General Motors, and Washington Mutual have previously declared Chapter 11.
Chapter 11 begins with a filing of the official petition in bankruptcy court. Either the debtor will file a voluntary petition for relief or the company’s creditors will file an involuntary petition. Most Chapter 11 filings are voluntary petitions. Once the case has been filed, the debtor is referred to as the “debtor-in-possession” and will usually continue its day-to-day operations. The court may bring in a trustee to temporarily operate the business by creditor(s) request or if there are findings of fraud, incompetence, or gross mismanagement by the debtor.
The company has four months to propose a reorganization plan that addresses how existing creditors will be paid and how the company intends to operate in the future. Various stakeholders in the company, including creditors, employees, taxing authorities, etc. are grouped into classes. The end goal of a Chapter 11 bankruptcy is the confirmation or approval of the plan.
If all the classes accept the company’s proposed plan, the confirmation is quick. If not, the company can compel acceptance through a procedure known as “cram down.” In a cram down, the company needs to demonstrate to the court that the plan is fair and equitable. With the court’s approval, the company can force through the plan without the consent of all the classes. The cram down plan may mean that some creditors or others don’t receive desired repayment or certain demands met. Once the plan has been confirmed by the court, the company/debtor must operate according to the plan or risk being dragged back into court and possibly forced to liquidate under Chapter 7.
A Chapter 9 bankruptcy is where a municipality seeks to reorganize its debts through extending debt maturities, reducing the amount of principal or interest, or refinancing the debt by obtaining a new loan. This chapter of the Bankruptcy Code is reserved for municipalities seeking debt relief. The origins of Chapter 9 bankruptcy arose from legislation during the Great Depression (1934). Unlike some other chapters, only a municipality may submit a plan that outlines how it intends to adjust its debts. No creditors or other parties in interest may submit a different proposal.
Chapter 12 is a very new addition to the Bankruptcy Code. Congress placed Chapter 12 in the Bankruptcy Code in 1986. Similar to Chapter 13, debtors propose a plan where creditors will be repaid over the course of three to five years. However, unlike Chapter 13, a debtor in Chapter 12 will only need to show that the plan met the “best interest of creditors” test in order to receive a discharge from the court.
No one chooses to declare bankruptcy on a whim. Once the choice has been made to declare bankruptcy, it’s important to determine which type(s) of bankruptcy you qualify for and gives you the best opportunity to come out on better footing. Carefully examine which chapter(s) you qualify to file under, the pros and cons of each qualifying type of bankruptcy, and understand what happens after you file for bankruptcy. Due to the complexity of bankruptcy, it can be very beneficial to enlist the services of a bankruptcy lawyer.
This article is intended to be helpful and informative. But even common legal matters can become complex and stressful. A qualified bankruptcy lawyer can address your particular legal needs, explain the law, and represent you in court. Take the first step now and contact a local bankruptcy attorney to discuss your specific legal situation.