All You Need to Know about Chapter 7 and Chapter 11 Bankruptcies
by
Kevin Scott Neiman on Jan. 08, 2017
Bankruptcy & Debt Bankruptcy Bankruptcy & Debt Credit & Debt
Summary: This article goes through each type of bankruptcy fillings (Chapter 7 - Liquidation, Chapter 11 - Reorganization, Chapter 12 - Adjustment of Debts of a Family Farmer with Regular Annual Income and Chapter 13 - Adjustment of Debts of an Individual with Regular Income) explaining it thoroughly.
Debts are treated differently depending
on the type or "chapter" of bankruptcy. There are 4 types of bankruptcy filings in the Federal Bankruptcy Code
(Title 11 of the United States Code):
·
Chapter 7 - Liquidation
·
Chapter 11 - Reorganization (or Rehabilitation
bankruptcy)
·
Chapter 12 - Adjustment of Debts of a Family
Farmer with Regular Annual Income
·
Chapter 13 - Adjustment of Debts of an
Individual with Regular Income
Chapter 7 bankruptcy is favored
by individuals and is the most common form of bankruptcy, in which most debts
are forgiven, and a variety of personal assets are sold in order to repay as
many remaining debts as possible. On the other hand, Chapter 11 bankruptcy is used
by corporations and business owners, debts being restructured in a way to make
repayment more achievable. What makes Chapter 7 and Chapter 11 bankruptcy different
is the fact that under Chapter 11, the debtor negotiates with creditors to
change the terms of the loan without having to liquidate (sell off) assets.
Chapter 7
Also called liquidation
bankruptcy or straight bankruptcy, Chapter 7 is often used by firms who are
past the stage of reorganization and must sell (liquidate) any un-exempt assets
to pay their creditors. The term liquidation, however, can be misleading, a
trustee can only liquidate nonexempt assets owned by the debtor. The creditors
collect their debts according to how they loaned out the money to the firm,
following the "absolute priority" rule. A trustee is appointed to ensure
that any secured assets are sold and that the proceeds are paid to the
creditors.
Secured debt is considered to be,
for example, loans issued by banks or institutions considering the value of a
specific asset. If any assets or residual cash remain after all secured
creditors are paid, these will be put together to be paid to any outstanding
creditors with unsecured loans. The main advantage of Chapter 7 is that the
debtor comes out without any future obligations on his discharged debts. The
debtor is seeking a discharge of his obligations to pay his debts. However,
bankruptcy does not wipe out most taxes, most school loans, child support or
alimony, most mortgages or liens and some other debts.
Chapter 11
Chapter 11 cases are the most
complicated of bankruptcy cases. This is the chapter used by large businesses
to reorganize their debts and continue operating. Corporations, partnerships,
and limited liability companies (LLCs) cannot use chapter 13 to reorganize.
They must stop all business operations if a chapter 7 bankruptcy is filed. A
lot of times, individuals and companies cannot obtain the relief they need
under chapter 7 or chapter 13. If they file for relief under chapter 7, the
company must end all its operations after filing the case.
Chapter 11 bankruptcy can also be
called rehabilitation bankruptcy, as it provides a company the opportunity to
reorganize its debt and to try to re-emerge as a healthy organization. In a
Chapter 11 case, the firm will contact its creditors in an attempt to change
the terms on loans (interest rate, dollar value of payments, etc.). A trustee is
also appointed, but rather than liquidating all assets to pay back creditors,
the trustee supervises the assets and allows business to continue. The difference
between Chapter 7 and Chapter 11 is that debt is not absolved in chapter 11. The
restructuring only changes the terms of the debt, so the firm must continue to
pay it back through future earnings.
Companies who were successful in Chapter
11 are typically expected to continue operating in an efficient manner with their
newly structured debt. However, they will file for chapter 7 and liquidate if
they are not facing any improvement. In both cases, there will be little (if
any) return on the common shareholders' investments.
When Should Bankruptcy Be Considered?
If you feel you are unable to
repay your debts, bankruptcy is an option to consider, but it should be
considered only as a last resort, because it comes with negative and long-term consequences
on an individual's or company's credit rating. There are, however, other ways
to discharge debt. Creditors often sell their unsecured debts to collection
agencies, who then adopt aggressive tactics to collect on the debt, or as much
of it as possible. Collection agencies often lack the necessary documentation
for legally enforcing debt obligations, so the Fair Credit Reporting Act can be
used in a way to get these unsecured debts voided.
