Many clients are often confused about what chapter of bankruptcy would be appropriate for them and understandably so. The bankruptcy rules are complex and ever changing. Making things more confusing, the media, family, friends and the public often refer to chapters incorrectly. This article is meant to give an overview of the primary differences between the bankruptcy chapters.
Who Files Chapter 7 Bankruptcy?
Chapter 7 bankruptcy is the most common filing by far. It is what most people are thinking of when they think of bankruptcy. Chapter 7 is a liquidation. This means when you file Chapter 7 bankruptcy, all of your non-exempt assets are taken by the bankruptcy court and sold or liquidated. That money is then given to your creditors according the bankruptcy rules of priority.
At first, this sounds really scary and many people fear they will lose everything. Fortunately, for most people, it’s not that bad. There are numerous exemptions that typically allow most people to keep the things that are important to them. The exemptions are also meant to make sure that filers aren’t left destitute and can maintain a basic (or normal) standard of living.
For example, most of your household items, TV, furniture, etc. will be exempt. Cars are exempt up to certain limits. Your home is exempt, up to a certain limit. If you have tools or items related to a business, they may be exempt, up to a certain limit. Your 401k & IRA’s are generally exempt. And the list goes on and on.
Bankruptcy is about disclosure. So it is very important that you disclose all of your assets to your bankruptcy attorney and the court when you file bankruptcy. If there is a particular asset or item you are concerned about, then you should talk to your bankruptcy attorney before filing so that you can best plan how to address it. Bankruptcy is also about timing, so having a good plan in place will allow you to take advantage of the bankruptcy rules and exemptions, without going overboard.
Income Limitations in Chapter 7 Bankruptcy
This biggest issue people usually face is qualifying for a Chapter 7 bankruptcy. After the bankruptcy rule amendments a few years back, it became much tougher to qualify. There are income limitations that exclude many people from qualifying because they make too much money. Sounds ironic, right? But the limits are pretty low, in the range of $45,000 to $60,000 depending on whether you’re married, have kids, etc. With rising costs, it is certainly possible to make a bit more than this and feel broke. If you’re close to the limit, you may need to take the “means test”, which takes a more detailed look at your income and expenses to determine if you qualify for a Chapter 7.
There is one important exception to this income limitation. If the majority of your debt was incurred because of your business, you may still qualify for a Chapter 7 regardless of your income level. This can be a game changer for small business owners who have been struggling but still have decent income.
Finally, a business itself can file Chapter 7 bankruptcy. However, for most businesses, it doesn’t make much sense. It may be easier just to wind down the business and close it up. This is because most corporate structures like LLC’s provide liability protection for the owners anyway. So if the business has no assets then it really isn’t collectible.
Once a Chapter 7 is filed and a few more procedures are complete, the court will typically issue a discharge order, discharging all your debts allowed by law.
Who Files Chapter 13 Bankruptcy?
If your income is too high for a Chapter 7 bankruptcy, and you don’t qualify for the business debt exception discussed above, then you may need to file a Chapter 13. A Chapter 13 bankruptcy is a reorganization and is called a “wage-earner’s” plan. That is because it is intended for people that make a higher income than the Chapter 7 limits allow. It also requires that you put together a plan to pay back some or all of the debt over a 3-5 year period (usually 5 years). If the plan is approved by the court, then any debt not paid after 5 years is discharged.
At first, Chapter 13 does not sound as appealing as a Chapter 7 because you have to pay a portion of the debt back to your creditors in a Chapter 13 and you don’t in a Chapter 7. It is true that many people would be better off in a Chapter 7, assuming they qualify. But there are some strategic advantages to a Chapter 13. It is a chance to reorganize your finances and propose a plan. This plan may allow you to keep certain assets that you would otherwise lose in a Chapter 7. Also, there are some rules related to mortgages than can be more favorable in a Chapter 13.
Sometimes, however, a Chapter 13 just doesn’t help or make sense for the client. Alternatively, it may make more sense for some clients to settle their debts without bankruptcy. Our firm offers both and can help you decide what’s best.
Who Files Chapter 11 Bankruptcy?
Chapter 11 bankruptcy is much more rare than Chapter 7 or 13. Chapter 11 is typically for high net worth individuals and for larger businesses. A Chapter 11 is a reorganization and can be very complex. Like a Chapter 13, a Chapter 11 requires that the debtor put together a plan to reorganize and pay what debts it can. And that plan must be approved by the bankruptcy court.
Also, like a Chapter 13, a Chapter 11 bankruptcy allows the debtor to hang on to many of the assets and restructure the debts to more favorable terms.
If you have questions about which Chapter of bankruptcy you qualify for, or want to find out if debt settlement would be a better approach, contact us for a consultation.