Bankruptcy Types: Definitions, Similarities & Differences

Bankruptcy is a complicated area of the law. On this, lawyers and members of the public agree. Part of the reason it is so complex is the fact that there is not one type of bankruptcy, but six different types.

Generally, individuals file Chapter 7 "liquidation" bankruptcy or Chapter 13 "reorganization" bankruptcy. But there are four other types, and though they are less common, their rules are not less complex.

It order to get the basics of bankruptcy, it's a good idea to get an overview of the six types, their similarities and their differences.

Most people understand bankruptcy to be a proceeding that assists a debtor who is overwhelmed by debts to make a fresh start. But getting a more complete overview of bankruptcy and reading up on bankruptcy basics are critical steps for anyone considering filing.

All bankruptcy cases must be filed in federal court, and the rules and procedures that must be followed are set out in the federal codes. State courts never hear bankruptcy cases, but state laws can impact some aspects of a bankruptcy filing, notably providing lists of exempt property.

The federal Bankruptcy Code sets out a number of different types of bankruptcy, each referenced by the chapter number in the code where it is described.

For example, Chapter 7 bankruptcy is the type of bankruptcy described in chapter 7 of the Bankruptcy Code, while Chapter 13 bankruptcy is described in chapter 13.

There are three common types of bankruptcy, and three less common types.

Those most common types of bankruptcy are:

• Chapter 7

(by far the most popular) Chapter 11 Chapter 13

The remaining three types are appropriate in specific circumstances that rarely involve an individual filer. These are:

• Chapter 9
• Chapter 12
• Chapter 15

Chapter 7 bankruptcy is by far the most common type of bankruptcy case filed and also the easiest and fastest to complete. This is the proceeding most people think of as bankruptcy. In this type of action, the debtor is permitted to keep some assets termed "exempt" under the laws.

Exempt property is intended to provide the debtor with the minimum assets they require to move forward in their lives. An example is the homestead exemption that allows a debtor to keep a certain amount of the equity in a primary residence.

The remainder of the debtor's assets are sold by a Chapter 7 bankruptcy trustee, and the amounts received are used to pay creditors. At the end of the proceeding, most of the debtor's unsecured debts, such as medical bills and credit card bills, are forgiven, or discharged.

Chapter 7 bankruptcy has some advantages that make it appealing to many debtors. The discharge of the remaining unsecured debts means that the debtor moves forward with a clean slate, truly offering a new start.

The disadvantages of Chapter 7 also involve the rules for discharge. That is, some types of debt cannot generally be discharged in bankruptcy. These include federal student loan debt; back child support or alimony payments; tax bills; and personal injury judgments arising from damages from driving under the influence of alcohol.

Another disadvantage pertains to all types of bankruptcy cases: Going through bankruptcy negatively impacts the debtor's credit score and stays on their credit report for up to 10 years.

Chapter 11 is a type of "reorganization" bankruptcy available to individuals or businesses. Although there is no debt-level limit and no required income level, Chapter 11 is the most complex and expensive form of bankruptcy. That's why individuals rarely file for Chapter 11.

A primary advantage of filing for a reorganization bankruptcy like Chapter 11 is that it allows a business to remain open and operating while its financial obligations are restructured. The debtor must prepare and submit a reorganization plan when they file, and that plan can build in lower payments and some debt forgiveness.

The disadvantages of Chapter 11 include the complexity of the filing. Debtors reorganizing under Chapter 11 are required to file with the court voluminous and detailed documents containing substantial financial information. Compiling the required information can be time-consuming and onerous. And, since court documents are public, anyone can read or even copy the materials.

Another disadvantage of filing for Chapter 11 bankruptcy is the cost. Since the proceeding is extremely complex, paying experienced legal assistance to complete it can be very expensive. In addition, shareholders and insiders might not come through a Chapter 11 very happily.

The bankruptcy court can impose restrictions on the salaries paid to the corporation's insiders including major shareholders, and under certain circumstances, the original shareholders of a debtor corporation may lose their position completely.

For example, when General Motors completed its Chapter 11 reorganization, the old stock plummeted in value, and the old shareholders lost their investments.

A bankruptcy under Chapter 13 of the Bankruptcy Code is also a reorganization bankruptcy, but it is available only to individuals, not businesses other than sole proprietorships. Like those filing for Chapter 11 bankruptcy, the Chapter 13 debtor prepares and submits a plan to reorganize their finances.

The plan must include monthly or biweekly payments from the debtor to the bankruptcy trustee who distributes the revenue to creditors according to the specifics of the reorganization plan.

The advantage of a Chapter 13 bankruptcy is that some debt forgiveness is possible. It can be built into the restructured debt, with the debtor paying less than 100 percent. Like Chapter 11, Chapter 13 permits the debtor to continuing working and managing their own finances to a large extent.

Chapter 13 bankruptcy can't be used by all debtors. There are debt limits – the debtor must not have total debt of over $2,750,000, including both secured and unsecured debt. The debtor must also have a regular income stream in order to be sure they can keep up with the payments to the trustee.

In addition, operating under a Chapter 13 plan takes between 36 and 60 months, during which time the debtor's finances are under the supervision of the bankruptcy court. That means that it will take years for the process to be completed, compared to four months in a Chapter 7 bankruptcy case.

Neither individuals nor businesses can file a bankruptcy under Chapter 9, which explains why it is one of the less commonly used types of bankruptcy. A Chapter 9 filing is available only to municipalities that have financial problems. This includes townships, cities, villages, counties and school districts.

A Chapter 9 bankruptcy is also reorganization bankruptcy, and like Chapters 11 and 13, it does not require the sale of assets. Rather, the parties work out a plan to resolve the debt over time. Like with other types of bankruptcy, when the petition is filed and accepted, an automatic bankruptcy stay is imposed, protecting the municipality from collection action.

Advantages to a Chapter 9 bankruptcy are many. The municipality can continue operating while the bankruptcy happens and it can do so with only minimal interference from the court. A trustee is never named to run the city or municipality; this is left almost entirely to the debtor.

In Chapter 9, the judge cannot force a city to sell assets or restrict the hiring of professionals or prevent attempts to issue additional unsecured debt. And the city can use the bankruptcy to reject or alter executory contracts like labor contract obligations

In addition, while creditors are permitted to propose competing reorganization plans in Chapters 11 and 13, they cannot do so in a municipality bankruptcy. Once the bankruptcy judge determines that the settlement plan proposed by the debtor is reasonable, the court can impose a settlement against a creditor's will. However, at least one class of creditor must agree to the plan before the judge can impose it.

What are the downsides? Chapter 9 is complex and can cost large sums for attorneys and accountants. In many states, an agency like a Department of Community and Economic Development during a Chapter 9 case might be asked to act as a plan coordinator. In addition, the municipality must show that it initiated substantial negotiations with its creditors.

Chapter 12, like Chapter 9, cannot be used by individuals or most businesses. This type of bankruptcy is reserved for farms and fisheries owned by individuals or corporations. This is also a reorganization bankruptcy where a debtor works with a bankruptcy trustee to put together a feasible payment plan for their debts over three to five years.

Only family farmers and fishermen who earn more than 50 percent of their income through the operation of these businesses can use Chapter 12.

The advantages of filing Chapter 12 bankruptcy are:

• No requirement for a means test or credit counseling.
• Debtor's assets are not at risk of liquidation.
• Creditor payments can accommodate seasonal earning trends.
  
• Home mortgages can be modified.
  
• Flexibility in the amount of debt a debtor can have.
• Plans need not be filed for three months.
  
• More exemptions are available than in other types of bankruptcy.
• Payments can be extended beyond the end of the bankruptcy period.

Chapter 15 bankruptcy is actually a set of rules and procedures that allow a U.S. Bankruptcy Court to cooperate with a foreign bankruptcy court when insolvent debtors, their assets or their creditors are located in both the United States and in another country. It is based on the model law enacted by many countries.

Essentially Chapter 15 permits a representative in a bankruptcy case filed in another country to access the U.S. Bankruptcy Court directly.

There are neither advantages nor disadvantages to Chapter 15 bankruptcy. It must be used in international bankruptcy cases.

Individuals have three bankruptcy options. They can file a petition under Chapter 7, Chapter 11 or Chapter 13.

There are not many individuals who will benefit from filing under Chapter 11, given how expensive it is. That means that the choice is between the liquidation approach of Chapter 7 and the reorganization bankruptcy of Chapter 13.

About 70 percent of bankruptcies are Chapter 7. They are the easiest and fastest to complete. These are best for people with high unsecured debt and few assets. The court will discharge unsecured debt at the end of the proceeding.

Chapter 13 is the best for those with assets to protect, like houses. The main reason for an individual to file Chapter 13 bankruptcy is to prevent the forced sale of an individual’s home.

Eligibility for filing bankruptcy is different under different chapters of the Bankruptcy Code.

Businesses and individuals can file under Chapter 7. Individuals, however, must meet certain income guidelines to establish that they truly cannot meet their debts. The Bankruptcy Code provides a means test for individual debtors filing for Chapter 7 bankruptcy.

The requirement is intended to curtail abuse of the Bankruptcy Code. The means test factors in income, assets, expenses and unsecured debt information.

The only eligibility requirement for an individual filing for Chapter 13 bankruptcy involves the level of their debt. All individuals, including those who are self-employed or operating unincorporated businesses, are eligible for Chapter 13 relief. They simply cannot have more than $2,750,000 in total debt, including both secured and unsecured debts.

Here's a quick guide on how to choose a type of bankruptcy:

• An individual should pick Chapter 7 or Chapter 13.
• A business should pick Chapter 7 or Chapter 11.
• A municipality should pick Chapter 9.
• A farm or fishery should pick Chapter 12.
• A debtor with creditors in several countries should pick Chapter 15.
  

Bankruptcy is a complex area of the law, but it is one of the few lifelines available to a debtor who finds themselves unable to pay their debts. For that reason, it's important to learn bankruptcy basics and understand the six different types of proceedings.

Of the different types of bankruptcy cases, one – chapter 7 – is liquidation bankruptcy. The others – Chapters 9, 11, 12 and 13 – are reorganization bankruptcies. In a liquidation bankruptcy, the debtor's assets are "liquidated" when they are sold by the trustee to pay down part of the amounts the debtor owes to creditors.

This is a sort of one-and-done procedure that doesn't take very long. A Chapter 7 is often completed within four months.

In a reorganization bankruptcy, the idea is to revamp the debt structure to allow the debtor to stay in business. There may be a little bit of loan forgiveness, but the proceedings largely focus on agreeing on a restructure for the debt that will work for the debtor. The plans usually last between three and five years.

The six types of bankruptcy are:

• ‌Chapter 7:‌ Liquidation bankruptcy.
• ‌Chapter 9:‌ Reorganization bankruptcy for municipalities.
  
• ‌Chapter 11:‌ Reorganization bankruptcy largely used by businesses.
• ‌Chapter 12:‌ Reorganization bankruptcy for farms and fisheries.
• ‌Chapter 13:‌ Reorganization bankruptcy for individuals.
• ‌Chapter 15:‌ International bankruptcy, where debtors, assets and/or creditors are in the U.S. and a foreign country.
  

Chapter 7 is foreclosure bankruptcy in which the debtor's nonexempt assets are sold to pay down amounts owing to creditors, and most remaining debt is forgiven, termed "discharged." Some types of debt, including family support, taxes and damages from DUI driving, cannot be discharged.

Chapter 7 is the most common bankruptcy filing, popular for individuals, and it is the quickest to accomplish and among the easiest to file.

Chapter 11 is a reorganization bankruptcy, where the debtor and creditors agree on a revamped payment plan. It is the only reorganization plan that businesses can use. It is expensive and extremely cumbersome to file, which is why it is rarely used by individuals. However, it is the only reorganization bankruptcy that most businesses qualifies for. There are neither debt nor income requirements.

Both Chapter 11 and Chapter 13 give debtors the opportunity to stay in business and restructure their finances. But there are important differences.

Chapter 11 is the only reorganization bankruptcy that a business can use. Individuals can file for Chapter 11, but they usually prefer to use Chapter 13 instead because Chapter 11 is the most expensive and time-consuming type of bankruptcy.

Filing Chapter 11 bankruptcy involves negotiating a reorganization plan that includes downsizing and expense reduction plans, as well as some debt forgiveness.

A bankruptcy under Chapter 13 of the Bankruptcy Code is also a reorganization bankruptcy, but it is available only to individuals. Those who file must not have total debt that exceeds $2,750,000; that is, combined secured and unsecured debt cannot exceed this amount.

In addition, the debtor must have regular income sufficient to cover the monthly payment to the bankruptcy trustee.

As is the case with Chapter 11, the debtor presents a reorganization plan for restructuring their debt, which must be approved by the creditors, and some debt forgiveness is also possible.

The repayment plan will provide regular (usually monthly, but occasionally biweekly) payments to the bankruptcy trustee. The trustee then distributes the payments to the creditors according to the reorganization plan specifics. It is sometimes possible for a debtor to complete Chapter 11 while providing less than full payment on debts.