Understanding the Major Bankruptcy Chapters

Bankruptcy law is tested on the CP exam, and understanding the differences among Chapters 7, 11, and 13 is essential. Each chapter serves a different purpose and is available to different types of debtors. This guide compares all three.

Chapter 7: Liquidation

Chapter 7 is often called "straight bankruptcy" or "liquidation bankruptcy." It is the most common type of consumer bankruptcy filing.

Purpose: To discharge (eliminate) most unsecured debts and give the debtor a fresh start
Process: A bankruptcy trustee is appointed to collect the debtor's non-exempt assets, sell them, and distribute the proceeds to creditors
Eligibility: Available to individuals and businesses. Individuals must pass the means test, which compares the debtor's income to the median income in their state. If the debtor's income is above the median, they may be required to file under Chapter 13 instead.
Timeline: A Chapter 7 case typically takes 3 to 6 months from filing to discharge
Exempt Property: Debtors may keep certain property that is "exempt" from liquidation. Exemptions vary by state and may include a homestead exemption, vehicle exemption, personal property exemption, and tools of the trade. Some states allow debtors to choose between state exemptions and federal bankruptcy exemptions.
Non-Dischargeable Debts: Certain debts survive bankruptcy, including most student loans, child support, alimony, certain tax debts, debts obtained through fraud, and DUI-related liabilities
Credit Counseling: Debtors must complete credit counseling before filing and a financial management course before discharge

Chapter 11: Reorganization

Chapter 11 is primarily used by businesses but is available to individuals as well.

Purpose: To allow the debtor to reorganize its debts and continue operating. The debtor proposes a plan of reorganization that restructures its financial obligations.
Debtor in Possession: Unlike Chapter 7, the debtor typically remains in control of its business operations as a "debtor in possession" (DIP). The DIP has the same powers and duties as a trustee.
Plan of Reorganization: The debtor has an exclusive period (typically 120 days) to file a plan. The plan must classify creditors' claims and specify how each class will be treated. Secured creditors, priority creditors, and general unsecured creditors are treated differently.
Voting: Creditors vote on the plan by class. A class accepts the plan if creditors holding at least two-thirds in amount and more than half in number of claims in that class vote in favor.
Cramdown: If not all classes accept the plan, the court may still confirm it over the objections of dissenting classes under certain conditions (the "cramdown" provision)
Small Business Debtors: Subchapter V of Chapter 11, added by the Small Business Reorganization Act, provides a streamlined process for small business debtors with debts below a specified threshold

Chapter 13: Wage Earner's Plan

Chapter 13 is available only to individuals with regular income.

Purpose: To allow individuals to keep their property while repaying all or a portion of their debts over a period of 3 to 5 years
Eligibility: Available only to individuals (not businesses) with regular income. The debtor must have secured debts below a specified limit and unsecured debts below a specified limit.
Repayment Plan: The debtor proposes a repayment plan that uses future income to pay creditors. The plan must be completed within 3 years (or 5 years if the debtor's income exceeds the state median).
Advantages Over Chapter 7: The debtor keeps all property (no liquidation). Chapter 13 allows debtors to cure mortgage defaults and keep their homes. It can also strip off junior liens on a debtor's residence if the property value does not support the lien.
Disposable Income Test: The debtor must commit all "disposable income" to the plan, which is income minus reasonably necessary expenses
Best Interests Test: Unsecured creditors must receive at least as much as they would in a Chapter 7 liquidation
Discharge: Upon completion of all plan payments, remaining eligible unsecured debts are discharged

Comparing the Chapters

Here is a summary of the key differences:

Who Can File: Chapter 7 is available to individuals and businesses; Chapter 11 is available to individuals and businesses; Chapter 13 is available only to individuals with regular income
Assets: Chapter 7 liquidates non-exempt assets; Chapter 11 and 13 allow the debtor to keep assets
Duration: Chapter 7 is quick (3 to 6 months); Chapter 11 varies; Chapter 13 lasts 3 to 5 years
Business Continuation: Only Chapter 11 is designed for ongoing business operations
Trustee: Chapter 7 and 13 always have a trustee; Chapter 11 uses a debtor in possession (trustee appointed only if there is cause)

The Automatic Stay

One concept common to all chapters is the automatic stay (11 U.S.C. section 362). Upon filing a bankruptcy petition, the automatic stay immediately halts virtually all collection actions against the debtor, including lawsuits, garnishments, foreclosures, and creditor harassment. Relief from the automatic stay may be granted by the court upon a showing of cause or if the debtor has no equity in the property and the property is not necessary for reorganization.

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Bankruptcy Chapters 7, 11, and 13 Compared