Bankruptcy is a legal process that an individual, a married couple or a business initiates in federal bankruptcy court.
A bankruptcy case allows a party who cannot pay their debts to have certain debts discharged. This means that some debts incurred before the bankruptcy filing are forgiven.
A Chapter 11 bankruptcy, also called a reorganization bankruptcy, allows the debtor remain in possession, or in control, of the business for the life of the case.
Some bankruptcy alternatives include:
- Debt consolidation, which typically involves taking out new loans to repay creditors
- Negotiating a settlement
- Repayment plan
A debtor can also request money from family, friends, or supporters such as fans of the business. They can also sell assets to raise funds to repay creditors and refinance mortgages on property that they own.
Disadvantages of Bankruptcy
The disadvantages of declaring bankruptcy include the court's monitoring of the debtor’s behavior and having to go through the bankruptcy process itself, which can be pretty lengthy.
A debtor may also face legal challenges, such as an adversary proceeding, a separate lawsuit within the bankruptcy case. Further, a debtor may see a lower potential for borrowing money and forming partnerships during and after the bankruptcy case, and will likely have a lower credit score for seven to 10 years after the case is closed.
Converting a Bankruptcy Case
If a Chapter 11 or Chapter 13 case is not proceeding well, a party can move for the case to be converted to a Chapter 7 bankruptcy. This means that the debtor’s bankruptcy estate, or the property that they own, can be sold and distributed to creditors.
If a debtor has an active business, they could see the business stopped and its assets sold to make payments to creditors.
Fix Credit Record Without Filing Bankruptcy
Methods of fixing credit without filing for bankruptcy include disputing negative marks on a credit report and asking for a goodwill deletion, which is a deletion of a negative mark based on the debtor’s good history with the lender and their current financial state.
In addition, a debtor can negotiate a different payment schedule in exchange for deletion of a negative mark. Some creditors offer hardship programs, which allow repayment of debt without incurring a negative mark.
A debtor can wait for the negative mark on their credit report to drop off. This usually takes 10 years. A debtor can consider debt consolidation, which means taking out a new loan with better terms to pay off another debt, but this may be difficult if a debtor has a low credit score.
Bankruptcy vs. Debt Consolidation Loan
Debt consolidation typically involves the combination of multiple debts into a single large debt. Debt consolidation can involve a better repayment schedule on fairer terms, such as a lower interest rate and a lower monthly payment. The quality of an offer of debt consolidation depends on the terms of the contract.
Filing for bankruptcy is preferable if the debtor will see a discharge of some of the debts.
The pros of debt consolidation include:
- Not having to incur the cost of a bankruptcy filing
- Not being monitored by the court
- Potentially not having as low a credit score as after the bankruptcy
Debt consolidation allows a party to avoid the risk of being required to convert a Chapter 13 or Chapter 11 case to a Chapter 7 case resulting in liquidation of assets.
Steps to Avoid Bankruptcy
There are alternatives to filing for bankruptcy. The first step on any path should be to talk with a credit counseling agency, as well as a bankruptcy attorney about their financial situation. The debtor can use these sessions to learn about their debt management plan or bankruptcy options, the cost of filing under different chapters, and the risks involved with each type of bankruptcy.
All individuals filing for bankruptcy must complete pre-bankruptcy credit counseling and a debtor education course before their debts are discharged.
Special Options for Small Businesses
Chapter 11 offers a streamlined process under two special categories for small business debtors. The first option is for a small business case. The second is for a subchapter V case. These cases are treated differently from a traditional Chapter 11 case.
The advantages of choosing them are that they have accelerated deadlines and the court will confirm a plan for reorganizing the business more quickly.
Debt Limits for Small Businesses
A small business case has a debt limit of $3,024,725 or less, not less than 50 percent of which arose from the commercial or business activities of the debtor. A subchapter V case has a debt limit of $7,500,000 or less, not less than 50 percent of which arose from the commercial or business activities of the debtor.
A debt limit is defined as the total amount of noncontingent liquidated secured and unsecured debt at the time the debtor files for bankruptcy.
Here, noncontingent means the amount of the debt does not hinge on other agreements; liquidated means the amount of the debt is known; secured means the debt is backed by collateral; and unsecured means the debt is not backed by collateral.
FAQs Regarding Alternatives to Bankruptcy
What is a 341 hearing?
This is a meeting of creditors in which the creditors verify the debtor’s identity and ask the debtor questions about their assets.
Do I need a bankruptcy attorney?
A party can represent themselves in a bankruptcy case. Yet bankruptcy is a highly specialized field of law. It is recommended that a party hire a bankruptcy lawyer to understand deadlines and requirements.
How much does filing for bankruptcy cost?
The cost varies depending on the chapter under which the debtor files.
As of November 2022, costs to file a new petition are $338 for a Chapter 7 voluntary or involuntary petition, $1,738 for a Chapter 11 voluntary or involuntary petition and $313 for a Chapter 13 voluntary petition. There are additional costs to file motions, such as a motion to reopen a case. There are also additional costs for adversary proceedings.
Is there a waiver of filing fees?
A debtor can file a request for a waiver of the filing fee or a request to pay a filing fee in installments. The filing fee does not include the cost of attorney’s fees.
Must a debtor list all their assets?
Yes, a debtor must make a full disclosure of all their finances when filing for bankruptcy.
What assets can a debtor retain after bankruptcy?
This depends on the state in which the debtor is based. States have different laws about exemptions, meaning the property that creditors cannot reach.
What debts cannot be discharged?
Alimony and child support; federal, state and local taxes; money that a debtor borrowed from a credit card issuer to pay taxes; fines and penalties for a criminal offense; and debts arising from a condominium or cooperative housing fee.
Jessica Zimmer is a journalist and attorney based in northern California. She has practiced in a wide variety of fields, including criminal defense, property law, immigration, employment law, and family law.