Financial challenges can strike anyone at any time. Under the US Constitution, Congress is granted powers to enact “uniform laws” on bankruptcies. In 1978, the Bankruptcy Code was created, and while it has been modified and amended several times during the intervening decades, it provides a national framework for dealing with all bankruptcy cases in the United States.
What Is Bankruptcy?
Bankruptcy is a legal filing on behalf of an individual, business, or organization that is unable to meet their financial obligations. The purpose is to provide relief and excuse all or a portion of a debt load. According to a 1934 ruling by the US Supreme Court, “It [bankruptcy] gives to the honest but unfortunate debtor…a new opportunity in life and a clear field for future effort, unhampered by the pressure and discouragement of preexisting debt.”
Liquidation versus Reorganization Bankruptcies
While US law recognized multiple “chapters” of bankruptcy, there are in essence only two types: liquidation and reorganization. Understanding the basic differences is crucial for choosing a path forward.
Liquidation: In a liquidation bankruptcy, the debtor must sell off all non-exempt assets. The proceeds from those assets go to pay creditors, in a priority order set by a judge.
Reorganization: Reorganization bankruptcy allows debtors to retain ownership of their assets, but creates a structured installment plan to repay creditors at least a portion of what the debtor owes them.
The Types of Bankruptcy in the United States
While there are two broad categories within US bankruptcy law, there are several different types, usually referred to by “chapter”. For instance, chapter 7 and chapter 13 are probably the best-known types, but several others may be preferable depending on a debtor’s position, needs, goals, debt load, and other factors.
In a Chapter 7 bankruptcy, all of a debtor’s non-exempt assets are taken over by a court-appointed trustee. The trustee will then sell those assets and use the proceeds to repay the debtor’s creditors. Note that the rights of the debtor and the rights of creditors must be balanced in this process, but many debtors have little or no non-exempt property. This means that these cases are rarely full liquidations, also called no-asset cases. In no-asset cases, creditors without a secured claim (credit card debt, for instance), will see no repayment of the debt owed to them. However, debtors must undergo what is called a “means test” before the judge making a final decision. This test is designed to determine the debtor’s actual financial means, thereby allowing an informed, accurate decision regarding creditor repayment to be made.
Chapter 9 only applies to municipalities. This is a method of restructuring debt, rather than liquidating it, and it works similarly to a Chapter 11 reorganization. Chapter 9 is only available to municipalities, which is a broad term covering everything from villages to entire counties.
Another well-known type of bankruptcy, Chapter 11 is designed to allow debts to be reorganized. In most cases, it is used by businesses and organizations, rather than by consumers. This format is usually chosen to allow the business to continue serving its customers or clients while reorganizing debts and making an effort to repay creditors, based on a reorganization plan submitted to the court by the organization. If the plan is approved, the debtor can usually reduce some debts and discharge others completely.
Chapter 13 is designed for private individuals who want to maintain ownership of their assets while making an effort to satisfy their creditors. In this type of bankruptcy, the debtor proposes a repayment plan that allows them to repay (most of) their creditors over a period of three to five years. A court-appointed trustee will make payments to all creditors if the plan is approved, and once all payments listed in the approved plan are made, a discharge will be received. Note that Chapter 13 discharge is broader than what is possible under Chapter 7.
Chapter 15 bankruptcy only applies to situations in which there is a case of cross-border insolvency. In this situation, an international organization has creditors located in another country, but pending insolvency creates repayment problems.
Should I File Bankruptcy?
The decision to file bankruptcy (any chapter) is not one to be made lightly. Even if bankruptcy is the right path for a debtor (whether a private citizen, a business, or another organization), the specific chapter will play a central role in what to expect during the process and the ultimate resolution of the debt load in question. Moreover, it is important to have access to experience and guidance throughout the process. At Parikh & Prasad PC, we work with clients to ensure their rights are protected and to give them the new start they need, unencumbered by preexisting debt.