Chapter 7 vs. Chapter 11 Bankruptcy

This is the story for anyone who thinks a bankruptcy is a bankruptcy is a bankruptcy. Not so. In fact, bankruptcies are like Nike sneakers: They come in a variety of styles, each fashioned to meet the particular needs of the applicant.

Named for the chapter of the federal bankruptcy code that describes them, two of the most common varieties are Chapter 7 and Chapter 11. Which one is right for the applicant depends on the details of candidate’s bleak circumstances.

Know this going in: The consequences of bankruptcy will have a punishing effect in the short- and long-term. Your credit rating will take a severe hit; you’ll have trouble financing any major purchases; potential employers may find you too severe a risk to hire; and your bankruptcy will stick to your credit history for at least seven years.

On the upside, bankruptcy — overseen by specialized federal courts — provides a civil and orderly resolution for individuals or businesses whose finances are a wreck. Bankruptcy is almost always painful. But it’s not the end of the world.

“Bankruptcy is a fresh start for a debtor,” says Cathy Peek McEwen, a Federal Bankruptcy Judge for the Middle District of Florida. “That’s the pep talk I give my law students, and to everyone who comes into my courtroom.”

Among the keys: Knowing the difference between the various bankruptcy chapters, and understanding which of them is best for your situation. Chapters 7 and 11 can be castor oil remedies for companies or certain individuals whose finances are so hopelessly tangled only bankruptcy can straighten them out.

How Chapter 7 Bankruptcy Works

Chapter 7 is the type of bankruptcy that most people imagine when they think of bankruptcy: Through a court-appointed trustee, Chapter 7 bankrupts — usually individuals; rarely businesses — sell their nonexempt assets (a key phrase) to clear as much of their unsecured debt as possible. The rest, with exceptions such as taxes and student loans, is wiped out.

This mutual destruction is why Chapter 7 bankruptcy also is commonly known as “liquidation” bankruptcy. However, a 2018 survey by the American Bankruptcy Institute revealed that 93% of applicants who properly filed exemption paperwork were able to protect all of their assets. All. Of. Their. Assets. That’s #AllOfTheirAssets.

What’s the trick? Debtors must qualify for Chapter 7 by surviving a bankruptcy means test. Is your monthly income lower than the median for a household of your size in your state? You’re in. File exemptions properly — fingers crossed — and become one of the 93-percenters.

Who doesn’t qualify? Applicants with above-median incomes who, after paying allowed expenses, have money left to address at least a portion of their unsecured debts.

How Chapter 11 Bankruptcy Works

Pay even the slightest bit of attention to financial news and you’ll learn about Chapter 11 bankruptcy. All the major airlines have done it. So have General Motors and Chrysler. Krispy Kreme and Hostess did it. So did, back in the day, Marvel Comics.

In Chapter 11 bankruptcy, companies and certain individuals ask the court to help them get relief from creditors while staying afloat and holding onto assets. Generally, the debtor develops a plan to change the operation of its business (or personal finances) with the idea of generating more profit and paying off debts. The debtor also gets the chance to renegotiate with creditors. Once the plan is approved by the court, it is put into motion.

Chapter 11 bankrupts win because they get a real fresh start, often while unloading certain legacy debts — unsustainable pension plans, for instance — that prevent them from getting into the black and staying there. Creditors win because they wind up getting far more than they would in a liquidation bankruptcy.

Individuals who choose Chapter 11 don’t qualify for Chapter 7 because their income is too high, and they have too much debt to qualify for Chapter 13. Think: Hollywood headliners and professional sports stars.

Differences Between Chapter 7 & Chapter 11 Bankruptcy

To recap, then: Chapter 7 is the least complicated of the various bankruptcy programs. It’s designed for low-income individuals or people with severely upside-down finances to quickly eliminate qualified unsecured debt like credit cards or medical bills.

Chapter 11 is for businesses and individuals who need breathing room to reorganize their finances. They have high, reliable income and valuable assets. They can get back on their feet if they’re able to renegotiate the terms of their debts.

Similarities Between Chapter 7 & Chapter 11 Bankruptcy

For all their differences, Chapters 7 and 11 bankruptcy have several things in common. Consider:

• The automatic stay — instantly blocks most creditors from harassing you for payment; the stay stops wage garnishments, levies, and certain lawsuits. Some legal actions may continue, including criminal cases, some family law cases, and government civil enforcement proceedings are immune to bankruptcy’s automatic stays. But don’t abuse the privilege: first-time bankrupts benefit from the stay; those who have filed and dismissed cases in the past six months can’t expect protection.
• Anyone can file — for Chapter 7 or 11: individuals, married couples, business entities. Also common to both: The required time period must pass before filers who have received a debt discharge can qualify for a second bankruptcy discharge.
• A credit counseling course — must be completed within 180 days before filing; proof of completion must accompany the petition and other official bankruptcy forms.
• A 341 meeting of creditors — must be attended by the filers, where documentation supporting the petition’s financial disclosures (tax returns, profit-and-loss statements, bank statements, and so on) is verified. Filers verify their identities, testify under oath, and answer questions posed by the trustee as well as creditors.
• There will be fees — Attorney’s fees. Filing fees. Administrative fees. Trustee fees. They can add up fast.

Is It Better to File Chapter 7 or 11? How Do I Choose?

It is not possible to make a blanket case for whether it’s better to file one type of bankruptcy over another. Nike makes shoes for golf, shoes for basketball, shoes for tennis, and shoes for running. Each is designed for its specialty, but is ill-suited to others. The same goes for varieties of bankruptcy.

Which chapter fits your situation depends on your particular circumstances.

• Chapter 11 bankruptcy protects assets, but can be shockingly expensive. Individuals who opt for Chapter 11 have substantial, reliable incomes and stuff they want to keep. Oscar winner Kim Basinger, Grammy winner Sir Elton John, Real Housewife Teresa Giudice, singers Meatloaf, Cyndi Lauper, and Toni Braxton, former heavyweight boxing champion Mike Tyson, ex-NBA star Allen Iverson, and rapper 50 Cent all went through Chapter 11.
• Chapter 7 is your better bet if you are hopelessly awash in debt from credit cards, medical bills, personal loans, and/or car loans and your income simply cannot keep up. As noted above, you’re most likely going to get to keep most of your assets while erasing your unsecured debt.

COVID-19 & Bankruptcy

The COVID-19 pandemic has spread into every aspect of modern life, including bankruptcy. One aspect: While bankruptcy proceedings ground on, many hearings have been held via telephone or web conferencing.

The March 2020 CARES Act contained certain provisions related to bankruptcy. Among them:

• The act expressly excluded payments made under federal law related to the pandemic from the definition of “current monthly income” for cases under Chapters 7 and 13.
• Bankruptcy provisions of the CARES Act were extended for a year by Congress and President Biden and now will end in March of 2022.

Get Help Choosing Between Chapter 7 & Chapter 11 Bankruptcy

Credit counseling for bankruptcy is not merely mandatory for anyone planning to file bankruptcy, it may be the only way to effectively decide which chapter is best for your situation — or even if bankruptcy is your best course of action.

Don’t leave this to friends, relatives, workmates, or clergy. Seek professional help. Seek out a reputable bankruptcy attorney, or a certified credit counseling agency.

An experience professional will help you sort the financial facts from your emotions, guiding you toward the best of your bankruptcy options, or perhaps even demonstrating that your condition, though difficult, isn’t as dire as you imagined. With effective professional counseling laying out the alternatives (such as a debt management program), you may yet avoid bankruptcy.

If bankruptcy proves inevitable, however, a professional credit counselor will also help you plan to rebuild your credit and financial life once your bankruptcy is finalized.