Chapter 7 vs. Chapter 11 Bankruptcy: What’s the Difference?
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Summary:
Comparing Chapter 7 vs. Chapter 11 comes down to how assets are handled. With Chapter 7 bankruptcy, a trustee liquidates all nonexempt assets to pay creditors. Chapter 11 bankruptcy allows businesses to retain ownership of their assets while executing court-monitored restructuring. Work with a professional bankruptcy attorney to understand the details of the different bankruptcy laws and which one might be better for you.
Let’s be honest, the best type of bankruptcy is no bankruptcy. It’s a life-altering event that can set businesses and individuals on a difficult financial path, all while trying to help them recover from overwhelming debt.
That being said, if you have to file bankruptcy charges, is one better than the other? How do you know if you’re filing for the correct type of bankruptcy? Keep reading to learn how Chapter 7 and Chapter 11 bankruptcy proceedings work to get creditors their due payment and debtors back on their feet.
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What is Chapter 7 bankruptcy?
Chapter 7 bankruptcy is “liquidation” bankruptcy. The United States Courts describes it as “the sale of a debtor’s nonexempt property and the distribution of the proceeds to creditors.”
Chapter 7 bankruptcy doesn’t include a repayment plan. Rather, it involves the liquidation of all assets to repay as much debt as possible. This type of bankruptcy is available to both businesses and individuals, but it’s most common for individuals.
Pro Tip
Don’t attempt to navigate through bankruptcy alone. Experts and the U.S. courts strongly recommend consulting an experienced attorney throughout the entire bankruptcy process. At a minimum, this article should not serve as legal advice, but rather an introduction to what to expect from these two types of bankruptcy.
How Chapter 7 bankruptcy works
Chapter 7 bankruptcy is common but complex. It requires the collaboration of debtors, creditors, and trustees. You can find details of the Chapter 7 bankruptcy process, including requirements and exemptions, in the Federal Bankruptcy Code. Here is an overview of that process.
- File a petition. First, you (as the debtor) have to file a petition to the bankruptcy court. Depending on the case, you may need to provide several additional pieces of information, such as a list of your assets and liabilities as well as any tax returns filed before or during bankruptcy proceedings.
- Appoint a trustee. Next, the bankruptcy court appoints a trustee to your case. Impartial case trustees are responsible for administering cases, liquidating assets, and more. They cooperate with you to create the bankruptcy case, classify your assets, and sell your property.
- Create an estate and liquidate. Once your case begins, an “estate” temporarily becomes the legal owner of your assets. The trustee works to distribute payments from the estate to creditors. All free and clear, nonexempt assets are liquidated to pay creditors by order of class.
- Discharge. In most cases, the court “releases debtors from personal liability for most debts and prevents the creditors owed those debts from taking any collection actions against the debtor.” This means you get a fresh start to build healthy financial habits. However, Chapter 7 discharge may come with exemptions that you should explore with legal counsel.
IMPORTANT! Any secured debt you have takes priority over unsecured debt. Secured debt may include a loan with a bank that is secured by a specific asset or an auto loan through a dealership. Once these loans and debts are repaid, any remaining assets are liquidated to repay your unsecured debts.
What is Chapter 11 bankruptcy?
Chapter 11 bankruptcy differs from Chapter 7 because it is “reorganization” bankruptcy. It allows debtors to propose a reorganization plan through which it will repay creditors over time. This form of bankruptcy can be especially helpful for business owners, as the process gives these owners the opportunity to come out the other side with their personal assets intact and a way forward for the business.
While individuals may file for Chapter 11 bankruptcy, it’s usually reserved for corporations, sole proprietorships, or partnerships. Chapter 11 gives businesses an opportunity to keep operating, stay afloat, and sometimes even borrow more money. Businesses find relief from Chapter 11 while keeping their assets and taking on the duties of a trustee.
How Chapter 11 bankruptcy works
The following is an outline of what to expect from Chapter 11 bankruptcy. The biggest difference between Chapter 7 and 11 bankruptcy is the repayment plan, which you’ll see in the fourth step.
- File a petition. Similar to Chapter 7 bankruptcy, Chapter 11 bankruptcy starts with filing a voluntary or involuntary petition to the local bankruptcy court. You (the debtor) must submit several supporting documents including a schedule of income and expenditures.
- Assign a debtor. In most cases of Chapter 11 bankruptcy involving businesses, you take on the identity of “debtor in possession.” This means that you (on behalf of your business) act as your own trustee and assume the rights and responsibilities thereof.
- Continue business operations. You get to continue your business operations without the weight of your debts. As the debtor in possession, you agree to report your business operations, schedules, and financial statements to the U.S. Trustee and creditors’ committee.
- Plan reorganization. As the debtor, you’ll develop a plan for reorganization and submit this plan (along with a disclosure statement) to the bankruptcy court. You’ll have to do so within 120 days after the petition was filed, but you can submit an extension request if you need more time. During your hearing, the court examines your plan and votes on whether to approve it.
- Discharge. Upon confirmation of the plan of reorganization, your business is discharged from some debts. You are then bound by a new contract to pay remaining debts and operate responsibly. Keep in mind that the court may revoke or approve modifying the reorganization plan within the post-confirmation period of 180 days.
If you fall short in executing your plan of reorganization and responsibly paying off debts, you may have to file for Chapter 7 bankruptcy.
Pro Tip
Are you a small business owner overwhelmed by debt? As long as you meet Bankruptcy Code requirements, you may be able to find relief under one of two special small business categories of Chapter 11 bankruptcy.
What’s the difference between Chapter 7 and Chapter 11 bankruptcy?
Chapter 7 and Chapter 11 bankruptcy both offer relief from financial hardships. They allow you to escape from mounting debt, at a cost. However, the two types of bankruptcy are fundamentally different.
Below is a summary of the aspects of Chapter 7 vs. Chapter 11 bankruptcy that differentiate them from one another.
| Chapter 7 | Chapter 11 |
|---|---|
| “Liquidation” bankruptcy | “Reorganization” bankruptcy |
| Used by individuals and businesses | Used mostly by businesses |
| All nonexempt assets liquidated to pay creditors | Businesses reorganize their debt obligations and business structure to recover from debt and operate more efficiently |
| Cases are assigned a trustee who manages and liquidates assets | “Debtor in possession” acts as case trustee and continues business operations under monitoring of U.S. Trustee and other parties |
| $245 case filing fee | Special cases for different ownership structures, small businesses, and real estate debtors |
| Not all debt absolved | |
| $1,167 filing fee |
IMPORTANT! When you file a petition, you “enact an automatic stay,” which stops debt collections and prevents creditors from taking legal action against you. So if you’re struggling with too much debt, it may be in your best interest to speak with a bankruptcy attorney as soon as possible. This is true of both Chapter 7 and Chapter 11 bankruptcy filings.
How to decide which type of bankruptcy to file
As you’ve seen, Chapter 7 and Chapter 11 are very different types of bankruptcy. So, which one should you choose if you’re considering filing bankruptcy? The answer greatly depends on your assets, your debt, and whether you are a business or an individual. It is best discussed with legal and financial experts.
Consider your bankruptcy eligibility
Keep in mind that not all individuals or entities qualify for bankruptcy. According to the United States Code (U.S.C.), individuals, partners, corporations, and other business entities are eligible for relief under Chapters 7 and 11. The following are additional eligibility requirements for bankruptcy:
- Individuals must not have a prior bankruptcy case within the past 180 days that the court dismissed because they didn’t follow court orders.
- Individuals must not have a prior bankruptcy case within the past 180 days that was voluntarily dismissed after “the filing of a request for relief from the automatic stay.”
- Debtors must complete a “means test” if their monthly income is more than the state median.
- Individuals must receive credit counseling from an “approved nonprofit budget and credit counseling agency” within 180 before filing for Chapter 7 bankruptcy.
Consult an attorney
From the information in this article, you should be able to get an idea of which type of bankruptcy is more suited to your situation. However, this should not be used as legal advice.
You should contact a bankruptcy lawyer to guide you through the bankruptcy process. They will help you select the most advantageous type for your situation and prevent as many additional losses as possible.
IMPORTANT! These aren’t the only two types of bankruptcy. Chapter 13 bankruptcy is another type of bankruptcy commonly compared to Chapter 7 and Chapter 11. You might even find that another option other than bankruptcy, such as debt settlement, is better for you. If you’re interested in speaking with a debt settlement company, take a look at some of the companies below.
FAQs
How much does it cost to file bankruptcy?
To file for Chapter 7, you’ll have to pay a $245 case filing fee, a $78 miscellaneous administrative fee, and a $15 trustee surcharge upon filing. Chapter 11 is a bit more expensive and requires a $1,167 case filing fee and a $571 miscellaneous administrative fee upon filing.
If you don’t have the money to pay for these fees upfront, the court may allow you to pay in four installments. If you still can’t make these payments, the court may waive them.
What does it mean to go from Chapter 11 to Chapter 7?
Some businesses file for Chapter 11 bankruptcy only to fall back into unmanageable debt. In these cases, the business files for bankruptcy again under Chapter 7 and liquidates assets to pay off debt.
How long will Chapter 7 last?
The process of Chapter 7 bankruptcy typically lasts four to six months. That said, it will stay on your credit for up to 10 years.
What do you lose in a Chapter 7?
You will lose all nonexempt assets in Chapter 7 bankruptcy. Exempt assets include your primary residence, primary vehicles, and assets needed for your work.
Is it better to file a Chapter 7 or 11?
Neither one is better than the other, as the “best” option for you depends on your situation. If you are an individual, Chapter 7 might be better for you. If you are a business and want to keep operating through bankruptcy, Chapter 11 might be better. However, you should always consult an attorney for guidance before filing.
How long does Chapter 11 stay on your credit?
Unfortunately, a Chapter 11 bankruptcy can stay on your credit for up to seven years.
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