What Are The Different Types Of Bankruptcies?

Bankruptcy is a legal tool for debt relief. United States bankruptcy laws offer different types of bankruptcy depending on the type of filer. The most common distinction here is people vs. businesses or personal vs. corporate bankruptcy. 

Each type of bankruptcy is named after a chapter of the Bankruptcy Code. The U.S. Bankruptcy Code is the federal law governing bankruptcy cases. Because it’s federal, it’s the same in the entire United States and the bankruptcy court is a federal court.

Bankruptcy Basics: What Is Personal Bankruptcy? 

Personal bankruptcy refers to a bankruptcy case filed by an individual or married couple. If a married couple files bankruptcy together, it’s called a joint bankruptcy filing. But, there’s nothing that says you have to file with your spouse. Sometimes it makes sense not to. 

Chapter 7 and Chapter 13 are the most common types of personal bankruptcy. Even though a bankruptcy can stay on your credit report for up to 10 years, many filers see a noticeable increase in their credit score within 2 years of filing their case. Personal bankruptcies can also be filed under Chapter 11 of the Bankruptcy Code, but that’s pretty rare. 

By the Numbers: Non-Business Bankruptcies filed between July 1, 2019 - June 30, 2020

Chapter 7 Bankruptcy 

Filing bankruptcy under Chapter 7 is often the most direct path to a fresh start for folks struggling with things like credit card debt, medical bills, or even a wage garnishment. To be eligible for Chapter 7, you have to show the bankruptcy court that your regular income isn’t enough to pay even a portion of your debts. This is called the means test. 

How Chapter 7 Bankruptcy Works

Chapter 7 is called the “liquidation bankruptcy” because the bankruptcy law requires that certain property is sold to pay your unsecured creditors in exchange for getting a fresh start. The sale (or liquidation) is handled by a bankruptcy trustee. 

The trustee can only sell property that is not protected by an exemption (called non-exempt property). If all of your property is covered by an exemption, it can’t be sold by the trustee. In that case, your creditors get nothing and you get to keep all of your belongings. 

In most personal Chapter 7 bankruptcy cases, all property is protected by an exemption under state law. If there are no non-exempt assets, most personal Chapter 7 bankruptcy cases last no more than 4 - 6 months. The bankruptcy discharge - the court order that eliminates your dischargeable debt - is usually granted about 3 - 4 months after the filing date. You can start rebuilding your credit as soon as that happens. 

Chapter 13 Bankruptcy

This is the second most common type of bankruptcy filed by individuals. Unlike Chapter 7 businesses (other than sole proprietors) are not allowed to file Chapter 13 bankruptcy. It’s called a reorganization because it involves a repayment plan that usually only pays a portion of the filer’s total debt. To file Chapter 13, your secured debt and your unsecured debt (including personal loans) can’t exceed a certain amount.^[1]

How Chapter 13 Bankruptcy Works

You create a budget based on your monthly income and your living expenses and tell the bankruptcy court how much you can afford to pay on your debts each month. The court and the bankruptcy trustee review your proposed repayment plan. Once it’s approved by the court, all you have to do is pay your disposable income to the trustee, and send in your tax return every year. Your remaining debt (other than student loans) is wiped out once done. 

Some people file Chapter 13 bankruptcy because they make too much money to qualify for Chapter 7 bankruptcy. Others choose to file Chapter 13 because it gives them a certain benefit they’re not able to get in Chapter 7. 

You can, for example, avoid the sale of nonexempt assets by filing Chapter 13. It also gives you the chance to pay back certain nondischargeable debts, like past due alimony or child support and pay off car loans with a lower interest rate. And - you can do it all in manageable monthly payments based on your regular income. 

Chapter 11 Bankruptcy

Even though individuals and married couples can file bankruptcy under Chapter 11, it’s not typically included part of a list of personal bankruptcy options. The court filing fee alone is more than $1,700 and bankruptcy attorney fees usually start somewhere around $15,000+. So, it’s an option, but it usually only makes sense if you’re a very high earner or business owner who can’t file a Chapter 13 reorganization bankruptcy because you have too much debt. 

Bankruptcy Basics: What Is Business Bankruptcy?

Business bankruptcy cases refer to bankruptcy proceedings for a business. Recent examples of business bankruptcy cases include Forever 21, Sears, and California Pizza Kitchen. 90% of all the Chapter 11 bankruptcies filed from July 1, 2019 to June 30, 2020, were filed by businesses.^[2]

Business Bankruptcy: Chapter 7 vs. Chapter 11

Businesses can file either Chapter 7 or Chapter 11 bankruptcy. Businesses who file Chapter 7 bankruptcy are in the process of shutting down. All of the business assets - from real estate to personal property - are sold and unsecured creditors are paid in order of priority. Businesses don’t get to claim exemptions - everything goes. 

A bankruptcy proceeding under Chapter 11, on the other hand, can be used to restructure the business and its financial obligations. The bankruptcy protections granted by the automatic stay give the business an opportunity to propose a payment plan. As of February 20, 2020, small businesses are able to file a less complicated version of Chapter 11 called Subchapter V. 

Other Types of Bankruptcy

The Bankruptcy Code contains three additional chapters of bankruptcy: Chapter 9, Chapter 12, and Chapter 15. 

Chapter 9 Bankruptcy

This type of bankruptcy allows municipalities (including cities, towns, and villages), counties, taxing districts, municipal utilities, and school districts to restructure their financial obligations. The Chapter 9 bankruptcy proceeding filed by the city of Detroit remains the largest municipal bankruptcy filing by debt to date. Through the Chapter 9 process, the Motor City restructured an estimated $18 - 20 billion of financial obligations.^[3] Before 2013, Alabama’s Jefferson County 2011 filing held the record with approximately $4.2 billion of debt.^[4]

Much like a wage earner’s plan under Chapter 13 or a Chapter 11 plan of reorganization, a bankruptcy proceeding under Chapter 9 allows the filer to propose a repayment plan to deal with its obligations. 

Since Chapter 9 does not cover states or territories of the United States, Congress had to pass the 2016 Puerto Rico Oversight, Management, and Economic Stability Act to allow the U.S. territory access to bankruptcy protection.^[5]

Chapter 12 Bankruptcy

A Chapter 12 bankruptcy gives family farmers and those operating a commercial fishing operation the ability to reorganize their debt without having to go through the expensive Chapter 11 bankruptcy process. It works similar to a Chapter 13 but includes specific provisions to deal with the unique nature of farming and fishing operations. Once the Chapter 12 repayment plan is completed, the filer receives a bankruptcy discharge. 

Chapter 15 Bankruptcy

Chapter 15 bankruptcy comes into play when an individual (or business) files a bankruptcy case under the bankruptcy laws of another country but has assets or liabilities in the United States. Its purpose is to provide an effective way for dealing with cases that involve cross-border issues and to ensure cooperation between foreign and U.S. bankruptcy courts. 

Let’s Summarize...

The types of bankruptcy contained in the U.S. Bankruptcy Code provides different types of relief for different types of filers. Your financial situation typically determines what chapter of bankruptcy best meets your goals. 

If you’re trying to stop a repossession due to a temporary loss of income, Chapter 13 bankruptcy may be right for you. If your car payment isn’t the problem, but you’re dealing with a wage garnishment from medical bills or credit cards, Chapter 7 may be a better path towards a fresh start. 

Either way, remember that bankruptcy is a safety net and - while it may not feel this way - there is no shame in using the United States bankruptcy laws for the purpose of getting a fresh start. That’s what they’re there for.