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Q&A: What are the differences between Chapter 7 and Chapter 11 bankruptcy?

Neerja Bhutani
by Neerja Bhutani, The Garrett Network  (@BhutaniPalmin)

A fundamental goal of the federal bankruptcy laws enacted by Congress is to give debtors a financial "fresh start" from burdensome debts.

According to Supreme Court 1934 decision:
‘It gives to the honest but unfortunate debtor …a new opportunity in life and a clear field for future effort, unhampered by the pressure and discouragement of preexisting debt.’

The purpose of the act has been again and again emphasized by the courts as being of public as well as private interest. Both Chapter 7 & 11 bankruptcies can be filed by Individuals, corporations or partnerships.

READ: I think I need to file for bankrtupcy and I don't know how

Below are the differences between these two kinds of bankruptcies:

Chapter 7 Bankruptcy: also called Liquidation proceeding is an organized liquidation of all non-exempt assets.

This bankruptcy is filed by people who have no financial resources to pay off their debt obligations.

To qualify for Chapter 7 bankruptcy one must pass the means test. The purpose of the means test is to figure out whether one has enough disposable income to pay off all the debts after subtracting certain allowed expenses and required debt payments, to repay at least a portion of your unsecured debts over a five-year repayment period.

If the debtor passes the means test, than the debtor receives discharge from all the obligations and personal liability of the discharged debt. Under the proceedings the debtor is allowed to keep the exempt assets.

READ: Are there alternatives to bankruptcy?

Some of the exempt items, but not limited to are:

Motor vehicles to certain value, necessary clothing, household goods & appliances, pensions, unpaid earnings, Social Security and unemployment compensation

Chapter 11 Bankruptcy: also called Reorganization, This is more often filed by businesses under financial duress.

Though Chapter 11 proceedings can be complex and expensive, however under the court supervised confirmed plan, the debtor can reduce its debts by repaying a portion of its obligations and discharging others..Under Chapter 11, the debtor normally goes through a period of consolidation and emerges with a reduced debt load and a reorganized business.

Chapter 11 plans typically provide for debtors to make payments to creditors over a period of three to five years. The bankruptcy court can extend the Chapter 11 plan with a longer term if one needs more time to make required payments.

READ: Should I contact a lawyer before filing for bankruptcy?

In case of small business debtors with real property mortgages or equipment loans, for example, often need extended payment terms.

If a company is successful in chapter 11, it will typically be expected to continue operating in an efficient manner with its newly structured debt.

 

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Neerja Bhutani has been in the financial planning profession since 1997. She co-founded Bhutani-Palmin Financial Planning in 2006 and is an hourly financial planner, providing independent, objective financial planning and advice to clients in Walnut Creek and Oakland, California.