What are the types of bankruptcies?

Chapter 7 bankruptcy

Chapter 7 is one of the two most common types of bankruptcy filed in the United States. Also known as “liquidation bankruptcy” or a “fresh start,” Chapter 7 involves selling off assets to pay as much debt as possible and then clearing most remaining debts (with a few exceptions).

It may give you a fresh start but also has serious, wide-ranging impacts. While you may not lose everything, the loss of assets can be tough to deal with. Chapter 7 bankruptcy also hits your credit hard. Credit scores typically drop immediately after filing, and Chapter 7 remains on your credit report for up to 10 years from the date you file. This can make it harder to secure new credit in the future.

How Chapter 7 bankruptcy works

Chapter 7 bankruptcy is available to both individuals and businesses. You must meet some requirements to qualify. You’ll need to undergo credit counseling or have completed it within the last 180 days. You also can’t have filed for a Chapter 13 bankruptcy in the previous six years or Chapter 7 bankruptcy within eight years.

Your household income needs to be below the median for your community. If it’s not, you’ll have to take a bankruptcy means test, which evaluates your ability to afford basic living necessities such as food and clothing. Means testing compares your monthly income and expenses against average expenses for households of similar sizes. The means test will determine if you can file for Chapter 7 bankruptcy or if you need to opt for Chapter 13 instead. ​​If you qualify for Chapter 7, here’s how it works:

1. Temporary stay: When you file, the court will place a temporary stay on your debts. This means collectors can’t take any action on them.
2. Asset review: A court-appointed trustee reviews your finances and assets and liquidates non-exempt assets. This can include things like jewelry, homes and any money in bank accounts. Exempt assets include “reasonably necessary” clothing and household goods, retirement plans and vehicles (up to a certain value). These rules can vary from state to state, so it's best to consult a legal professional if you have questions about what you’ll be required to liquidate.
3. Partial debt payment: The liquidated assets are used to pay as much of your debt as possible.
4. Discharge of remaining debt: Most remaining debts are discharged, with exceptions such as child support, student loans, unpaid taxes and court fines.

Chapter 13 bankruptcy

Chapter 13 bankruptcy is a type of bankruptcy for individuals (and sole proprietors) who have an overwhelming amount of debt but still have sufficient income to make at least partial payments. It’s essentially a repayment plan. Unlike Chapter 7, Chapter 13 allows you to keep your assets while making structured payments over three to five years. Any remaining eligible debt is then discharged.

To qualify for Chapter 13 bankruptcy, you need to have regular income and have submitted federal and state (if applicable) tax returns for the previous four years. There is also a maximum amount of debt that’s eligible for Chapter 13: $465,275 in unsecured debt and $1,395,875 in secured debt.

How Chapter 13 bankruptcy works

The court determines the amount and terms of the repayment plan. That amount can’t exceed 15% of your monthly disposable income, which is determined by the court after reviewing your financial situation and the results of a means test. The duration of the plan is based on your income relative to the local median household income — if you fall below the median, you’ll get a three-year term, and if you meet or exceed the median, you’ll get a five-year term.

Chapter 7 vs. Chapter 13

Chapter 7 has stricter income requirements compared to Chapter 13. Your income must be below a certain threshold to qualify. Chapter 7 involves liquidating your assets (and sometimes losing your home), but your debts are generally cleared in four to six months. With Chapter 13, you get to keep your assets, but the repayment plan lasts at least three years. The other major difference is that Chapter 13 bankruptcy stays on your credit report for seven years, while Chapter 7 stays for 10 years, which could make Chapter 13 easier to recover from.

» MORE: Debt settlement vs. bankruptcy

Chapter 11 bankruptcy

Chapter 11 bankruptcy is technically available to anyone, but it’s most commonly used by businesses due to its cost and complexity. It enables businesses to continue to operate while restructuring their finances and debts — unlike Chapter 7, where businesses are shut down and their assets liquidated.

In fact, that’s the main purpose of Chapter 11 bankruptcy: to prevent a business from shutting down.

How Chapter 11 bankruptcy works

As the business carries out the plan, it operates under court supervision. This means major financial decisions, such as the sale of assets, will need court approval. The business then begins making payments according to the terms of the agreed-upon plan.

1. Petition is filed: First, the business files a petition for Chapter 11 bankruptcy. Upon filing, a stay goes into effect, halting any collection activities against the company.
2. Reorganization plan: The business then comes up with a reorganization plan that outlines how it’ll restructure and pay off debts. The plan can include downsizing or closing and selling divisions to aid in debt payoff.
3. Plan review: The creditors have the opportunity to review the plan and offer feedback or negotiate terms with the business.
4. Court hearing: Once an agreement is reached, a court hearing is held to review and confirm the plan.

Different types of bankruptcies

Chapters 7, 11 and 13 are the most common types of bankruptcy, but not the only ones. There are also Chapters 9, 12 and 15, which are more specialized to handle less common situations.

• Chapter 9 bankruptcy is for municipalities. That includes towns, cities and counties. Like other types of bankruptcy, Chapter 9 protects the municipality from its creditors while it develops and implements a plan to restructure and pay back debt. It works like Chapter 11 in that the court grants a stay from creditors, and then the town negotiates a repayment plan.
• Chapter 12 bankruptcy is specifically geared towards family farmers and fishermen. Farmers and fishermen who have regular annual income and who meet certain debt limits are eligible. The farms and fisheries must be family-owned. Again, the general process is similar to Chapters 11 and 13 in that the farmers negotiate a payment plan, and payments are made over three to five years. However, Chapter 12 is different because it’s designed to be less complex and costly than other types of bankruptcy.
• Chapter 15 bankruptcy is used in cases with foreign bankruptcy proceedings. The aim is to help foster cooperation between U.S. and foreign courts and to help businesses with international presences stay afloat through financial hardship. Chapter 15 can’t be filed without a foreign bankruptcy proceeding.