What are the Differences Between Chapter 7, Chapter 11 and Chapter 13 Bankruptcy?

In what most of us would call a normal world, bankruptcies are filed each day. However, during these times when more and more people are dealing with the financial fallout associated with COVID-19, it is estimated that numerous individuals and businesses will be filing for bankruptcy in the months and years ahead. Since the bankruptcy process is complex, confusing and will have a significant impact on a person's finances and particularly their credit, it is a decision that should be made only after careful thought, and as a last resort. If this is something you are considering, you should know the key differences between Chapter 7, Chapter 11, and Chapter 13 bankruptcies.

Repayment Plans

When most people start considering bankruptcy, they assume the process will involve a repayment plan where they will have to repay their creditors. However, that is not always part of the plan. If an individual or qualifying business such as an LLC, partnership, or corporation that has assets that can be liquidated files Chapter 7, no repayment plan is required. However, you will be required to liquidate or sell all nonexempt assets so that the money gained can be used to repay creditors. However, Chapter 11 and Chapter 13 bankruptcies do have repayment plans as part of the agreement, with the majority of plans extending three to five years.

Secured and Unsecured Debts

In most bankruptcy filings, individuals and businesses have an assortment of secured and unsecured debts. While secured debts are a bit harder to eliminate even through bankruptcy, unsecured debts such as credit cards or medical bills are mostly, if not completely, eliminated once Chapter 7 proceedings begin. Yet, when filing Chapter 11, unsecured debts are dealt with separately and are never included with other debts. Instead, repayment of all debts is determined by what is in the best interest of the creditors, not the individual or business filing bankruptcy.

Chapter 11 and Businesses

While Chapter 7 and Chapter 13 are bankruptcies most often used by individuals, Chapter 11 is generally reserved for businesses seeking reorganization of their finances. Though used mainly by large corporations, it can also be beneficial to small business owners. Considered the most complicated of the three bankruptcy processes, Chapter 11 should always have experienced attorneys and CPAs guiding you through each step of the way. Once Chapter 11 is filed, a business has up to 18 months to create and submit a reorganization plan that will restructure its debts so that all creditors can be repaid.

Stopping Collection Actions

When individuals get in over their heads financially and cannot pay their bills, they know all too well just how aggressive collection agencies can be when trying to obtain payments for unpaid bills. In many cases, collection agencies will use wage garnishments and other drastic measures to obtain the necessary funds. However, once Chapter 7 or 13 bankruptcy is filed, all collection actions against the individual must immediately stop. In addition, filing Chapter 13 can potentially save your home from foreclosure. Though you must continue to pay your mortgage during this time or risk having your lender start foreclosure proceedings in court, having filed Chapter 13 can give you extra time needed to try and make sure you don't lose your home.

Is Chapter 7 or 13 Best for You?

As for whether you should file Chapter 7 or Chapter 13 bankruptcy, this will depend on many factors. In most instances, Chapter 7 will be best if you own little or no property, have a low income level, have debt that is mostly unsecured, and do not have the financial resources needed to commit to a repayment plan. However, if you have student loans, income taxes that are unpaid, or court-ordered support obligations such as alimony or child support, Chapter 13 is usually recommended, since debts of this nature will not be eligible for discharge. Consult with your CPA and bankruptcy attorney for individual recommendations tailored to your situation.

Negotiations with Creditors

If you are concerned about having to negotiate with creditors to make sure your debts are repaid, the good news is that this will not be part of the process if you decide to file Chapter 7 bankruptcy. However, should you need to file Chapter 11 or 13, it will be imperative you have a skilled bankruptcy attorney on your side who can advise you concerning the negotiations and act on your behalf with creditors. Unfortunately, most creditors are not concerned about your financial situation, but instead simply want all or most of their money as fast as possible. Therefore, make sure the repayment plan eventually submitted to the court is one you are comfortable with and know will work for you and your finances in the short and long-term.

Impact on Your Credit Score

Though there are many differences between these three types of bankruptcy plans, one area where they are all the same is the impact they have on your credit score. In almost all cases, expect your credit score to drop 100-200 points immediately upon filing bankruptcy. Also, once a bankruptcy is on your credit report, it may stay there as long as 10 years. 

Bankruptcy and the Pandemic

Under the CARES Act passed by Congress to provide financial relief to individuals and businesses during the pandemic, some changes have been made to bankruptcy filings. For example, if you file Chapter 11, filing requirements and costs have been reduced, and the debt threshold has been increased to make this a viable option for more businesses. In addition, if you file Chapter 7 or 13 bankruptcy, any government stimulus payments received are not included in income calculations. Finally, if you can prove the pandemic has caused you tremendous financial hardship, repayment plans may be modified or extended.

Due to the many complexities associated with each of these three types of bankruptcy, never assume you will be able to navigate the process by yourself. Instead, if you need help organizing and analyzing your financial situation to determine whether or not bankruptcy should be considered, consult soon with an experienced and knowledgeable CPA for advice on how to proceed.