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Filing Bankruptcy: Chapter 7 vs. Chapter 13 vs. Chapter 11 Bankruptcy

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Bankruptcy is a court proceeding that involves examining your assets and debts. The court decides if you have the means to pay all, some or none of your debt. Filing bankruptcy is a serious step with long-term credit and financial consequences, so it should be used as a last resort. However, in some cases, filing Chapter 7, Chapter 13 or Chapter 11 bankruptcy might be the right decision for you. Work with a legal and financial professional to help you decide what actions are right for you.

When comparing your options, it’s important to understand the differences between the three most common forms of bankruptcy. If you’re considering filing for bankruptcy and need to choose between these three types, consult an experienced attorney. The information below offers some education to get you started, but an attorney can look at your situation and help you decide which chapter is best for you, or if another option is better for your situation.

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    Key Takeaways

    • Chapter 7 bankruptcy doesn’t require a repayment plan but does require you to liquidate or sell nonexempt assets to pay back creditors.
    • Chapter 11 bankruptcy is a business reorganization plan, often used by large businesses to help them stay active while repaying creditors.
    • Chapter 13 bankruptcy eliminates qualified debt through a repayment plan over a three- or five-year period.
    • Chapter 7, Chapter 11 and Chapter 13 bankruptcies all impact your credit, and not all your debts may be wiped out.

    How Chapter 7 Bankruptcy Works

    Chapter 7 is the most common type of bankruptcy and is often referred to as a straight bankruptcy. Under Chapter 7, you can eliminate most of your unsecured debts and some secured debts by surrendering your assets. Unsecured debts are debts not secured with collateral, including most personal loans and credit cards.

    Qualifying individuals can file for Chapter 7, but certain businesses can also file. Partnerships, LLCs or corporations with assets that can be liquidated to cover debts, can also qualify. Liquidation involves the sale of your assets to pay what’s owed to your creditors. Some assets are exempt from sale, but all nonexempt assets may be included in the liquidation process.

    When you file a petition for Chapter 7 bankruptcy, typically all collection actions against you should come to a stop. This means creditors should no longer be able to garnish your wages, call and demand payment or initiate a lawsuit against you. Report collection actions to your attorney, so they can communicate with your creditors.

    About 40 days after filing your petition, a meeting with your creditors occurs. You must agree to answer all questions asked by the trustee during this meeting under oath. If your Chapter 7 bankruptcy is successful, you receive a discharge that formally releases you from personal liability of your debts that were included in the bankruptcy. Work with your attorney to determine what, if any, debts you are still responsible for.

    What Does It Mean to File Chapter 11 Bankruptcy?

    Filing Chapter 11 bankruptcy is usually utilized by businesses. It involves submitting a reorganization plan to restructure debts to help repay creditors over time. It’s most often used by large corporations, but can also help certain people and small-business owners if they don’t qualify for Chapter 7 or 13. Chapter 11 is a more complicated bankruptcy filing, that isn’t typically used by individuals.

    Those filing a Chapter 11 have approximately four months to come up with a reorganization plan, but in some cases, this timeframe may be extended up to 18 months. When creating your reorganization plan, you place each of your creditors into its own class. Unsecured debts are placed in a separate class and never lumped with any other debts. Priority for repayment is placed on certain debts, which means these are paid before others. The plan must be in the best interest of the creditors, not the company or individual filing.

    How Chapter 13 Bankruptcy Works

    Chapter 13 is the second most common type of bankruptcy and used primarily by individuals. The goal of Chapter 13 is to eliminate your debt by creating a repayment plan to pay back all or a portion of what you owe over three or five years. You make monthly payments to a court trustee, and the trustee distributes the money to your creditors. At the end of your plan, the remaining unpaid debts are discharged.

    Filing Chapter 13 creates an automatic stay that stops most collection actions, which generally means creditors can’t seek wage garnishments, make calls demanding payment or file lawsuits. Automatic stays also protect your co-debtors and can save your home from foreclosure. However, you must continue to pay your mortgage or the lender can get the court to start foreclosure proceedings. Work with your attorney, so they can communicate with your creditors and work with you to determine what debts you should continue to pay, if any.

    Chapter 13 bankruptcy works especially well if you can afford to pay some, but not all, of your debt. If you’re faced with unsecured debts, including credit cards and medical bills, Chapter 13 helps you achieve a more manageable and affordable payment. It also protects your property while giving you time to pay off your debts and attorney fees via a monthly payment plan.

    Is It Better to File Chapter 7 or 13?

    Chapter 7 is generally more affordable compared to Chapters 13 and provides a relatively quicker way to get out from under your debts. Filing Chapter 7 might be a good option if you:

    • Own little or no property
    • Have an income level that falls below the means threshold
    • Have mostly unsecured debt, such as medical bills, credit card debts and personal loans
    • Can’t commit to a repayment plan for the next three or five years

    When you have debts that won’t be discharged, such as unpaid income taxes, domestic support obligations or student loans, Chapter 13 may be the better option. Chapter 13 bankruptcy is also typically used when you want to save your home from foreclosure. If you have a high income that disqualifies you for Chapter 7 and you can afford to pay some of your debt, Chapter 13 might be your only option. You will need to work with your attorney to determine which option is right for you.

    What’s the Difference Between Chapter 7 and Chapter 11 Bankruptcy?

    The biggest difference between Chapter 11 and Chapter 7 is that Chapter 11 is a reorganization bankruptcy, while Chapter 7 is a liquidation bankruptcy. So if you file for Chapter 7, you’ll have to sell your assets to pay as many creditors as possible.

    Chapter 11 is rarely used for individuals. If you do qualify, it lets you negotiate with your creditors to modify the terms of your debts and create a repayment plan without having to sell your assets. While individuals and businesses can utilize either type of bankruptcy, Chapter 7 is typically favored by individuals. Chapter 11 is designed more for business owners and is much more complex.

    How Bankruptcy Affects Your Credit

    Whether you file Chapter 7, Chapter 11 or Chapter 13, your credit score will suffer. Bankruptcies stay on your credit score for seven to 10 years, depending on the filing type. They also cause a large drop to your credit score immediately. That drop can be between around 130 and 200 points, depending on where your credit was prior to the filing.

    But in the long run, bankruptcy may actually help you positively impact your credit score. That’s because it positions you in a more realistic financial situation so you can begin to make timely payments on your bills. If you manage your finances responsibly going forward, that can be reflected in your credit score. But it will take time, so start working on good financial habits now.

    Bankruptcy During the COVID-19 Pandemic

    The federal CARES Act, which is the stimulus package meant to provide some financial relief during the COVID-19 pandemic, has some impact on bankruptcy law and filings. They include:

    • The CARES Act streamlines some of the filing requirements for businesses seeking to file Chapter 11 bankruptcy. It also reduces some of the costs if debtors follow a 90-day filing requirement for their reorganization plan. The CARES Act also increases the debt threshold to make Chapter 11 an option for more businesses.
    • For Chapter 7 and 13, the CARES Act ensures government stimulus payments are not included in income calculations related to qualifying for the bankruptcy or managing Chapter 13 repayments. Those who have already confirmed a Chapter 13 plan and experience a financial hardship because of coronavirus may also be able to modify and extend their plan payments.

    Is Bankruptcy Right for You?

    It depends, and only you can make the final decision about whether you should file or what type of bankruptcy is best for you. Consumer bankruptcy law is very complex, so it’s always a good idea to consult an attorney when making these decisions. For example, it’s not a given that all your debts will be discharged. Some debts must be repaid, either through the bankruptcy plan or outside of it.

    You’ll also have to pay filing fees and attorney’s fees. The total cost of your bankruptcy depends on how you file, where you live and what issues might come up during the bankruptcy. Before you meet with a lawyer, be prepared with your debt and income and  pull your free credit report so you understand exactly where you stand with creditors and how your credit might be impacted by bankruptcy.

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