Types of bankruptcies

I'm sure most of you have been in the position where you're at the store trying to make a purchase and your card gets declined - it's a bit shocking and leaves you feeling embarrassed. Bankruptcy can feel that same way, but there are a few different nuances to it that, when you understand them, makes the idea of bankruptcy a bit less intimidating and scary.

It's important to note that even if bankruptcy is the choice you make to help with debt you can't seem to get out from under, it's not the end and you can recover.

What is bankruptcy and the bankruptcy process?

The concept of bankruptcy is when you go to the court and tell them "listen I can't pay my debts, I need help." From there, the court will look at your assets and liabilities - what you personally own and what you owe others (cash versus a loan), and determine whether all or part of your debt can be forgiven.

When determining to forgive either all or part of your debt, they may take everything you own in order to erase your debt, or they can choose to allow you to keep your things but on the condition that you make a plan to pay your debts back. It truly depends on the situation.

Bankruptcy laws

We won't get super technical about the bankruptcy laws, but they are covered under Article I, Section 8 of the Constitution. It was enacted in 1978 and allowed various bankruptcy courts across the country to use the Federal Rules of Bankruptcy Procedure and local rules for each court to decide whether to give the debtor a discharge of debts.

Whether or not the debtor actually appears in court depends on the type of bankruptcy they are filing for - which I'll talk more about next.

6 types of bankruptcies

Within the Bankruptcy Code there are six different types of bankruptcies and they are each described and outline based on chapters within Article I, Section 8 of the Constitution. As I mentioned before, depending on the type of bankruptcy filings, you may not have to appear in bankruptcy court, the six different types of bankruptcy filings are:

• Chapter 7 - liquidation
• Chapter 13 - repayment plan
• Chapter 11 - large reorganization
• Chapter 12 - family farmers
• Chapter 15 - foreign debtors
• Chapter 9 - municipalities

Chapter 7 bankruptcy: liquidation bankruptcy

Chapter 7 bankruptcy is the most common type, called liquidation bankruptcy, and it includes liquidation of your assets (what you own) in order to pay off your debts (what you owe), and any unsecured debt, such as credit cards, will typically be forgiven. That being said, there are certain debts that are forgiven under Chapter 7, which includes student loan debt and debt due to unpaid taxes.

The process for Chapter 7 includes a court appointed trustee that oversees the liquidation of your assets in order to pay off your secured debts, but there are downsides to filing Chapter 7.

Pros

• Some debts qualify for forgiveness (i.e. credit cards and medical bills)
• Depending on the state you're in, you may be able to keep some assets, like your car, house, and retirement accounts.
• Common for those that don't make enough to pay off the debts they owe

Cons

• Stays on your credit report for 10 years
• Required to attend a meeting with all creditors who basically interrogate you about your financial situation.
• In order to not liquidate assets you owe money on, you need to resign a loan agreement and continue to make payments
• School loans and tax debt are excluded
• You are unable to declare bankruptcy again for 8 years

Honestly, declaring bankruptcy is a con in and of itself, but by looking at the specific pros and cons of each chapter of the bankruptcy code, it can help paint the picture of what you may be able to do instead, or which case better fits your current financial obligations.

Chapter 13 bankruptcy: repayment plan

Chapter 13 bankruptcy allows you to reorganize debt into a monthly payment plan. It's not eliminating your debt, doesn't require your to liquidate your assets, but instead create a debt repayment plan that works with your current financial situation.

Essentially, how chapter 13 bankruptcy works is that through a bankruptcy proceeding, the court approved a repayment plan to pay back a portion of your secured and unsecured debts over a three to five year time period. How much you pay a month depends on the amount of debt you have and your disposable income.

Pros

• You get to keep your assets and avoid liquidation
• Allows you to catch up on your debt
• Broad range of debt

• unsecured debt of less than $419,275
• secured debt of less than $1,257,850

Cons

• Courts force a strict budget and monitor your spending
• Three to five year payment plan - could be lower on your own budget
• Stays on your credit record for seven years
• Can't file chapter 13 bankruptcy again for two years

The biggest issue with this type of bankruptcy case is that if you create a budget for yourself and stay consistent, you could see debt relief way sooner than three to five years - and you won't have the courts breathing down your neck or a personal bankruptcy on your credit report.

Chapter 11 bankruptcy: business assets & large reorganization

Unless you own a business, you typically won't be filing bankruptcy under chapter 11. It is similar to Chapter 13 in that it a reorganization of your debt, but it doesn't focus on personal loans or personal property, it focuses on business operations and business debt.

These bankruptcy cases allow a business owner to develop a plan to repay their debts while still being able to operate and the federal courts and creditors need to approve this plan in order for it to go into effect. There are specific cases where individuals, such as real estate investors, could qualify for chapter 11 bankruptcy if they have too much debt to file chapter 13 but have assets and properties that are of higher value.

Chapter 12 bankruptcy: family farmers

Chapter 12 is similar to chapter 13, but it is specifically for farmers and fisherman. What it does is allows them to keep their assets, or at least some, and avoid them facing foreclosure. It is another chapter that's geared towards a specific type of situation, like chapter 11 bankruptcy is geared towards large and small business owners.

Chapter 15 bankruptcy: foreign debtor

The main purpose of chapter 15 bankruptcy is to give foreigners access to U.S. bankruptcy courts to help them settle their consumer debt. It's specific to international bankruptcy and isn't very common, a debtor qualifies under chapter 15 when the debtor or their property is subject to bankruptcy laws of more than one country - including the United States.

Bankruptcy basics gives an overview of the Service members' Civil Relief Act which provides bankruptcy protection to members of the military

Chapter 9 bankruptcy: municipalities

Chapter 9 bankruptcy is highly specific to school districts, taxing districts, towns, cities, an other municipal utilities to pay back the debts they owe. It is similar to chapter 11 in that it is a reorganization of debt, but specifically for municipalities.

How can you avoid filing for bankruptcy?

If you think about the total population being around 331.9 million, in 2023 only 416,607 individuals filed for bankruptcy. This means that 0.13% of American's filed for bankruptcy in 2023, LESS than 1%. It is possible to get your finances in order and become debt free without filing for bankruptcy.

Get on a budget

Budgeting is by far the most important and helpful thing you can do no matter what state your finances are in. And instead of having the United States Courts determine your budget and spending habits if you file under chapter 13, you can instead create your own budget and avoid the courts breathing down your neck and end up becoming debt free faster.

Increase your income

Again, the simplest thing you can do besides getting on a budget is finding a way to increase your income, whether that be getting a side hustle, a second job, or negotiating a higher salary at your current job. The more money you can bring in the easier it will be to pay your debts.

Sell your own stuff

Filing under chapter 7 means that the court will liquidate your assets anyway, but you are not in control of how it's done or what is sold. If you take control of this you can ensure you're getting value from the items you're selling and use that to pay off your debt.

What chapter do you use to file bankruptcy?

Unless you are a business, a foreigner, a municipality, or a farmer, you're likely going to file under chapter 7 bankruptcy or chapter 13. Determining which one fits your current financial status will depend on a few factors:

• Qualifications (i.e. income, where you live, etc.)
• Timeline
• How long it stays on your credit reports

There are other things to consider that may be more personal such as how each chapter affects unsecured and secured debt and whether it stops or prevents foreclosure. It's ultimately up to you to make this decision, but know that there are alternatives to filing for bankruptcy and even if you do, it's no the end and you will recover.

Let's Recap

No matter what your situation, bankruptcy is not the end of the road and you will recover from it if you chose to file. That being said, there are alternatives to filing for bankruptcy that can allow you to avoid personal bankruptcy on your credit reports, get you on a path to paying creditors what you owe, and avoiding bankruptcy attorney fees.

There are various chapters of the United States Bankruptcy Code that apply to different types of bankruptcy protection. Chapter 7 applies to individuals and leads to the liquidation of all your assets to pay off debts with your unsecured debt, like credit cards, being forgiven. Chapter 13 involves the reorganization of your debt in the form of a payment plan and a court-ordered budget. These are the most common and the ones that apply widely to individuals.

You can avoid filing for bankruptcy by creating a budget, finding ways to increase your income, selling valuable items you own to repay debts, and truly finding a way to manage your finances. Debt and bankruptcy are not the end of the road. 

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