What Are the Different Types of Bankruptcies and Which One Is Right for You? 

Bankruptcies are filed when people and organizations default on their debt. Whenever a person or entity has unresolved debt, their credit rating goes down, they are targeted by collectors, and there may be liens placed on their assets. Filing for bankruptcy allows the defaulted borrowers to wipe their slate clean under certain conditions set by bankruptcy courts. While never an easy way out of debt, bankruptcies stop collections activities and bring balances down to zero, which can allow you to reset and work toward a better financial future.

What Are the Types of Bankruptcies?

There are several different bankruptcy types, and they differ from one another in significant ways: 

• Chapter 7 - Liquidation: Sells non-exempt assets to discharge most debts.
• Chapter 9 - Municipalities: Allows cities or towns to reorganize debts.
• Chapter 11 - Reorganization: Used by businesses or individuals to restructure debts.
• Chapter 12 - Farms and Fisheries: Tailored for family farmers and fishermen to reorganize debts.
• Chapter 13 - Repayment Plan: Enables individuals to repay debts over 3-5 years while keeping property.
• Chapter 15 - Foreign Cases: Handles cross-border insolvencies involving assets in multiple countries.

Understanding different bankruptcy types can help you if you ever accrue an unmanageable amount of debt or explore bankruptcy records to learn more about a potential employee, tenant, or borrower.

Chapter 7 Bankruptcy - Liquidation

The simplest and most common bankruptcy type is the Chapter 7 bankruptcy. A person who wants to file for Chapter 7 bankruptcy can list the exempt property when filing and, if uncontested for 30 days, will be protected from seizure as part of the bankruptcy process. 

A court-appointed trustee then distributes the remaining assets. The trustee can sell these assets and distribute the revenue to creditors that were owed money. The debtor is released from most debt liability in exchange, but the bankruptcy is listed on their credit report for up to ten years, and the credit score drops dramatically. Still, you can rebuild your credit score over a few years with time and sound financial decisions.

A surprising statistic about Chapter 7 bankruptcies is that the trustee closes the case in almost 99% of individual bankruptcy cases without selling anything that belonged to the debtor. This is because you request exemptions for any assets that you need for daily life, like primary cars and houses.

Chapter 9 Bankruptcy – Municipalities

Chapter 9 Bankruptcy is the rarest type of bankruptcy, with less than 200 occurring in the US per year. It is reserved for municipalities that are struggling financially and allows them to reorganize what they owe and get some relief from their lenders. Examples of this relief include:

• Refinancing the debt to achieve better terms, such as a lower interest rate
• Reducing the principal amount of the debt in order to settle it faster
• Lowering payments, usually through extending the duration of the repayment terms

While rare, occasionally, municipalities struggle with debt, and allowing them the option of filing Chapter 9 bankruptcy can help them recover over time.

Chapter 11 Bankruptcy – Reorganization

Businesses often use Chapter 11 bankruptcy, but it is also available for individuals. In this bankruptcy structure, commonly referred to as business bankruptcy when applied to companies, the debtor proposes a reorganization of finances with the goal of repaying their creditors over a specified period of time. The court considers the proposal and approves or denies it. If the court approves it, the debtor needs to follow the reorganization plan and make payments to creditors. 

Filing Chapter 11 can help collection activities stop and, in some cases, can allow the debtor to seek other financing. Like Chapter 7 bankruptcy, Chapter 11 also stays on one’s credit report for ten years.

Chapter 12 Bankruptcy – Farms and Fisheries

Chapter 12 bankruptcy is very similar to Chapter 11 – it also requires the debtor to reorganize to repay debt. Chapter 12 is unique in that it was explicitly introduced to assist farming and fishing businesses. The business has to be generating revenue, and at least a portion of the debt needs to be from farming or fishing business activities. This bankruptcy type stays on your credit report for up to ten years.

Chapter 13 Bankruptcy – Repayment Plan

Chapter 13 bankruptcy is a structure that allows for steady repayment of some, or all of the debt owed. Best in situations where an individual or company still has income coming in, this bankruptcy type allows the court to set the repayment plan based on your financial situation. 

Under Chapter 13, all of the debtor’s disposable income is used to repay debt. The only exempt earnings are those needed to cover living basics, like food, shelter, transportation, clothing, and healthcare expenses. One advantage of Chapter 13 over Chapter 7 is that the Chapter 13 bankruptcy is only on your credit report for seven years.

Chapter 15 Bankruptcy – Foreign Cases

Unresolved debt does not just occur in the US and is not limited to the borders of one country. Chapter 15 bankruptcy was introduced in 2005 to help aid cooperation between bankruptcy courts in different countries. When bankruptcy occurs internationally and US assets or residents are affected, a Chapter 15 bankruptcy may be filed. 

This bankruptcy type originated from a UN recommendation, and currently, 48 countries have adopted the same or similar measures. Having an international option for bankruptcy helps to reduce the risk for creditors of foreign entities.

Whether you are in a situation where you need to resolve a large amount of debt or if you are trying to understand the bankruptcy records of other individuals and organizations, it helps to understand that the six main types of bankruptcies all have their unique structures and rules. 

Which Type of Bankruptcy Is Right for Your Situation?

When it comes to filing for bankruptcy, most people find themselves choosing between Chapter 7 and Chapter 13. Here’s a quick breakdown to help you decide:

• Chapter 7 is ideal if you have a low income and few assets. It’s a faster process where your non-exempt assets are liquidated to pay off debts, and the rest is discharged. But you need to pass a means test to qualify—too much income, and you might be directed toward Chapter 13 instead.
• Chapter 13 works better if you have a steady income and want to keep your property. This option allows you to repay your debts over three to five years while catching up on missed payments for secured debts like a mortgage or car loan.

The choice between Chapter 7 and Chapter 13 often hinges on your income level and what you want to protect. If you’re worried about losing your home or other important assets, Chapter 13 might be your best bet. On the other hand, if speed and wiping out debt are your priorities, Chapter 7 could be the way to go.

Deciding which type of bankruptcy is right for you isn’t easy. It’s often worth consulting with a bankruptcy attorney who can help you navigate the complexities and find the best path forward based on your specific financial situation.

Bankruptcies are not one-size-fits-all, and the nature of the financial struggles will dictate which one is the best option. To navigate bankruptcies, you can seek a bankruptcy lawyer’s advice or speak to a Certified Public Accountant (CPA). 

The main takeaway is that while bankruptcies are unpleasant, time-consuming, and require debtors to make significant changes, they gradually allow individuals and businesses to get to a clean slate. Individuals and companies alike have been able to recover their financial positions over time and set new goals. 

Bankruptcies can change over time, so it is essential to conduct timely research when you need relevant information. Often seen as a last resort, in some cases, bankruptcies can be more advantageous financially than continuing to carry unrealistic amounts of debt.

FAQ

What Is the Difference Between Chapter 7 and Chapter 13?

Chapter 7 and Chapter 13 are the most common types of personal bankruptcy. Chapter 7 is a liquidation process where non-exempt assets are sold to pay off creditors, and most remaining debts are discharged. It’s typically faster and is often chosen by those with lower income and few assets. Chapter 13, on the other hand, is a reorganization process where you keep your assets and create a repayment plan to pay off your debts over three to five years. It’s suitable for individuals with a steady income who want to protect their property, such as a home or car.

What Type of Bankruptcy Is Best?

The best type of bankruptcy depends on your financial situation. Chapter 7 is usually best if you need a quick resolution and have limited income and assets. Chapter 13 is better if you have a stable income and want to keep your property while repaying your debts over time. Chapter 11, often referred to as a business bankruptcy, is typically used by businesses for reorganization, and Chapter 12 is designed for family farmers and fishermen. Consulting with a bankruptcy attorney can help you determine which option is best for you.

Which Type of Bankruptcy Will Most Individuals File For?

Most individuals file for either Chapter 7 or Chapter 13 bankruptcy. Chapter 7 is more common because it’s faster and discharges most debts without requiring repayment. However, Chapter 13 is also widely used by those who have sufficient income to repay their debts and want to avoid losing significant assets like a home.

Are There Any Differences in the Bankruptcy Process Across Different States?

Yes, there are differences in the bankruptcy process depending on the state. While the basic federal bankruptcy laws apply nationwide, states have their own rules regarding exemptions—what assets you can keep during bankruptcy—and other procedural details. For example, the amount of home equity you can protect (homestead exemption) varies by state. It's crucial to understand your state’s specific laws when filing for bankruptcy.

What Happens if Someone Is Considering Bankruptcy but Their Debt Doesn’t Neatly Fall Into One of These Categories?

If your debt situation doesn’t fit neatly into Chapter 7 or Chapter 13, you may need to explore other options or consult with a bankruptcy attorney. There are specialized types of bankruptcy, like Chapter 11 for businesses or Chapter 12 for farmers and fishermen. In some cases, alternative debt relief options, like debt consolidation or negotiation, might be more appropriate than bankruptcy. An attorney can help assess your situation and recommend the best course of action.