Differences between Bankruptcy Chapters
The Bankruptcy Code is divided into different chapters of which three are most common – Chapter 7, Chapter 11 and Chapter 13. Both Chapter 7 and Chapter 11 are available to businesses and individuals, whereas Chapter 13 is reserved exclusively for individuals. Individuals can file under any of the three chapters either as individuals or together with their spouse as a couple. All three chapters afford debtors an automatic stay, which prevents creditors from taking any action to enforce their claims without first seeking relief from the bankruptcy court. The following is a brief description of the relief afforded by each of the chapters, for more information please click on the links within the article or consult with a bankruptcy attorney.
Chapter 7 allows a debtor to liquidate assets to pay off debts. Only individuals who satisfy the means test and businesses that will no longer continue to operate are able to file Chapter 7. The Chapter 7 estate, or the assets to be liquidated, includes only those assets owned by the debtor at the time of filing. This means that any income made by an individual after filing for Chapter 7 is not subject to the bankruptcy and can be used for the individual’s ongoing living expenses. Additionally, certain assets can be identified as exempt from the bankruptcy estate, such as clothing, home furnishings, a vehicle or the family home. Exempt assets may be retained by the Chapter 7 debtor and are not subject to liquidation, however, all exemptions have dollar limits set by either federal or state law.
Unlike other chapters, a Chapter 7 debtor does not remain in control of the estate, instead, a Chapter 7 trustee is appointed to collect and liquidate the debtor’s assets. The trustee is able to investigate and recover assets not turned over to the trustee. Once the trustee recovers and then liquidates the Chapter 7 estate, he or she will assess the validity of the claims filed by creditors and exemptions filed by the debtor, and distribute the proceeds in order of priority. Creditors will generally not recover debts in full, so an individual Chapter 7 debtor will receive a discharge from any debts that cannot be paid. Certain debts such as student loans, alimony and taxes are non-dischargeable. A Chapter 7 debtor can only receive one discharge within seven years.
A business debtor is not eligible for discharge, unless in special circumstances, but a Chapter 7 business debtor ceases to be an operating entity after liquidation so generally a discharge is unnecessary.
Chapter 11 allows a debtor to reorganize finances while retaining assets, generally through the sale of certain assets to pay down debts and/or the refinancing of existing debts. Given the complexity and cost of Chapter 11, it’s most often used by businesses. However, Chapter 11 may be the only option available to an individual with income greater than what is allowed by the Chapter 7 means test, and secured debt in excess of what is allowed by Chapter 13 (addressed below). This is often the case where an individual owns large amounts of real property, but does not have sufficient liquidity to pay his or her debts as they come due. In Chapter 11, a debtor generally manages the estate (unless a trustee is appointed) and proposes a plan of reorganization that addresses the treatment of creditor claims. Certain creditors are entitled to vote to approve or disapprove a plan. However, a Chapter 11 debtor can “cramdown” a plan over the negative vote of creditors in certain circumstances. If a debtor is unable to confirm a plan of reorganization, the case may be converted to Chapter 7 or dismissed.
The major benefit of Chapter 11 over Chapter 7 is that debtors are able to retain assets and are not required to liquidate all assets. For individuals, this means keeping assets beyond just the statutory exemptions; for companies, this means being able to continue operating the business.
Chapter 13 is available exclusively for individuals with income (or debt) within certain guidelines established annually. The purpose of Chapter 13 is to provide relief to individuals with steady income that have fallen behind on their monthly debt payments, while allowing them to retain assets in excess of the statutorily-proscribed limits. Similar to Chapter 11, a Chapter 13 debtor generally remains in control of the estate and proposes a plan for payment of creditors. Unlike Chapter 11, a Chapter 13 debtor’s plan does not need to be approved by creditors, provided it meets certain criteria. A Chapter 13 plan generally provides for creditors to receive payments derived from a percentage of the debtor’s income over a period of between 36 and 60 months.
A Chapter 13 debtor does not receive a discharge until all plan payments have been made, and then receives a slightly broader discharge than in a Chapter 7. Most notably, a Chapter 13 debtor can receive a discharge of damages resulting from willful or malicious injury to property or debts arising from divorce settlements.