People new to bankruptcy often get confused when faced with multiple chapters, which tend to raise a few pointed financial questions: Why do bankruptcies have chapters? What do they mean? Do I have to choose one? Is one better than the other? Bankruptcy can be scary, and is a serious financial choice, but it can also be a powerful way to dramatically improve your economic outlook when it feels like all hope is lost.
“Chapters” simply refers to the different legal types of bankruptcy that you can file for. Yes, you have to pick one of the common chapters, which are numbered based on where they show up in the legal code. Chapter 7, 11, and 13 are the common options, particularly Chapter 11 and 13. (Interestingly, there are also Chapter 9, 12, and 15 bankruptcies, but these apply to specific entities like farmers, banks, or foreign debtors.) Read on to find out how the popular bankruptcy options may be able to help you manage or, indeed, get rid of debt.
Chapter 7 bankruptcy is designed for both individuals and businesses, but it is most commonly associated with individuals. However, if you own a failing business, a Chapter 7 option may be also exactly what you need. This option allows a person to fully “cancel” or erase specific types of debt. There is no last-minute bailout or reorganization, as some types of bankruptcy allow.
However, this type of bankruptcy may not erase all types of debt. Some of the most important debts – think of mortgages, for example – are still paid, and the court will sell assets like your house to pay them. This can be a steep cost, but it does fully get rid of your debts and, by law, leaves you with enough to live. This type of bankruptcy can take several months to conduct and can only be used once every six or eight years, depending on the court’s decision.
Who counts as a debtor if a business chooses a Chapter 7? Well, the first paid are usually banks and other financial organizations that hold large, secured loans based on those business assets. Then unsecured lenders are paid, and if there is any money leftover (which does not often happen) it is distributed among investors. The business disappears, but its debts are also cleared, which can be very valuable for business owners worried about liability issues.
Chapter 11 bankruptcies are also available to individuals and businesses, but they are more commonly used by businesses or business owners. This option allows a business to stay open, unlike a Chapter 7. It is essentially a long pause that puts the brakes on company activity and allows the business to completely rethink its approach. Creditors are kept at bay with an automatic stay that prevents them from collecting debt, and the debtor is allowed to retain control of all assets.
The debtor then has around 5 months to submit a plan of reorganization, essentially a plan of how to reconstruct the business into a profitable enterprise. If the court is impressed by the plan and the way the debtor is managing its assets, the plan is put into effect and the loans are lengthened or replaced with new versions. This is more of bankruptcy avoidance than a full bankruptcy.
Chapter 13 is the other common bankruptcy option for individuals. You can think of it as a mix between Chapter 7 and Chapter 11. You are allowed to keep most of your primary assets like your house and your car, but at a cost: Together with a trustee, you must submit a plan for debt repayment that will last for the next several years. Smaller or lesser debts may be erased completely, but you will still have to pay off the most important loans according to this plan.
A Chapter 13 avoids the worst effects of a total Chapter 7 bankruptcy and helps you create a new financial plan. However, it does not work if you owe too much money and you have to stick to the repayment plan precisely in the following years, during which time it may be very difficult to take out any new loans.
Whatever option you may be considering, get professional legal and financial advice. Bankruptcy is not a process to be taken lightly, but if executed properly, it can provide great relief and a fresh start.
Charles Hicks is a professional blogger that shares is expertise on avoiding bankruptcy in your personal finances. He writes for The Ballard Law Group, a top bankruptcy law firm in Atlanta GA.