Deciding between the type, or “chapter,” of bankruptcy (Chapter 7 VS Chapter 11 bankruptcy) is difficult because both options are used for declaring bankruptcy in businesses.
When a business can’t move out of its debt situation, it can file for business bankruptcy and start over from scratch. Or, companies that are in dire financial situations can choose between Chapter 7 bankruptcy and Chapter 11 bankruptcy should they find themselves in such a situation. Businesses can file bankruptcy in different ways under the Federal Bankruptcy Code (11 u.s.c. 1328).
So, what is the difference between these? And, which type of bankruptcy to file in what situations?
A Chapter 7 bankruptcy, however, is primarily intended to liquidate the debtor’s non-exempt assets, distribute the proceeds to creditors, and discharge the debtor’s prepetition debt, thus giving the debtor a fresh start. It is typical for debtors to file Chapter 7 cases voluntarily. On the other hand, a Chapter 11 bankruptcy aims to help businesses and individuals with large debts reorganize their finances. And in both cases, a bankruptcy attorney help in filing a bankruptcy case in court.
The rest differences between Chapter 7 and Chapter 11 will be discussed in the following blog further. Let’s take a look!
What is Bankruptcy Chapter 7?
Chapter 7 bankruptcy involves the liquidation of assets. Debtors pay their debts by selling their personal assets. Debtors who have secured loans must pay them first because creditors can demand collateral like car loans, home equity loans, mortgages, etc. The debtor may pay unsecured loans after paying secured loans, such as a credit card, an unsecured personal loan, etc if he/she still has some money remaining. Even you can file for bankruptcy to avoid judgment liens.
Companies or individuals who file for this chapter shut down their operations and dismiss their management. Neither the company nor the individual can continue to operate. In simple terms, when a business files for bankruptcy, it gets shut down.
This chapter authorizes the court to appoint one or more trustees for the purpose of analyzing the liquidating assets’ actual value. Afterward, only one can decide who should be paid first.
A liquidation may not generate enough money to pay off all debts. Consequently, the debtor pays only secured loans and ignores unsecured loans in this case.
A chapter 7 debtor can start over without having to pay any repayments, so there is no repayment plan left. Debtors do not have a limit on how much debt they can owe.
What is Bankruptcy Chapter 11?
In this chapter, debt is restructured and repayments are made. Under this chapter, the debtor files bankruptcy in order to save their assets. The filing of bankruptcy in this way avoids the liquidation of assets.
Under this, businesses file for bankruptcy chapter 11 when they’re able to run their operations, but are unable to pay their debts. Thus, the company or individual has a chance to stand again and run their business. Filing for Chapter 11 is subject to certain terms and conditions. For a company to be able to operate, it must generate regular income, and a restructured payment schedule must be filed with the court.
As a result of this case, the court appoints a trustee or instructs the owner to reorganize loan repayments and change some repayment terms
This allows the debtor to manage their loan repayment efficiently. Debtors can also use it to negotiate repayment plans with creditors. There are new terms and conditions regarding loan repayment for both creditors and debtors.
What Is the Best Time to Consider Bankruptcy?
Those who feel they will not be able to repay their debts have the option of declaring bankruptcy under 11 u.s.c. 1328. Nevertheless, bankruptcy should be considered only as a last resort, since it can negatively impact your credit rating in the long run.
Chapter 7 vs Chapter 11 Bankruptcy – Key Difference
The main difference between Chapter 7 and Chapter 11 bankruptcy is regarding the payment of debts. Chapter 7 is a liquidation bankruptcy intended for individuals or businesses that cannot pay their debts. While Chapter 11 is a reorganization bankruptcy intended for businesses focusing on restructuring debts to become financially viable.
Among the various bankruptcy programs 11 u.s.c. 1328, Chapter 7 is a more reliable option. This is specially designed for low-income people with several upside-down finances to quickly eliminate qualified unsecured debt like credit cards or medical bills. This is also known as an order of discharge chapter 7.
On the other hand, chapter 11 is for businesses and individuals who require additional space to reorganize their finances. They have high, reliable income and valuable assets. They can pay their debts but require a little time to renegotiate the terms of their debts.
Here is the key difference between Chapter 7 and Chapter 11. Let’s take a look!
Type: A chapter 7 bankruptcy involves liquidating assets, whereas a chapter 11 bankruptcy involves restructuring loan repayments.
Processing Time: As the whole process of liquidation progresses, chapter 7 usually takes about 4 to 6 months, but in chapter 11, there is a long-term process. There is a possibility that the company debt payment period may be extended during the time of restructuring.
Closure: An individual or company in chapter 7 is not able to operate, whereas, in chapter 11, the company gets a second chance to operate.
Advantages: A chapter 7 debtor cannot start over with a new repayment plan without any debt limitations. The company is given a second chance in chapter 11 to continue operating.
Comparative Table – Chapter 7 vs Chapter 11 Bankruptcy
Chapter 7 | Chapter 11 |
It involves the liquidation of assets | It involves the restructuring of debt repayments |
Payment for secured and unsecured loans is paid after liquidating assets. | Term and condition change for debt repayment |
Debt can be forgiven in some cases. | There can be a delay in payment, but it cannot be forgiven |
A court appoints a trustee to analyze liquidating assets’ value | The court appoints a trustee or instructs the owner to create a new repayment structure |
Can pay as many as debts | There is a possibility that creditors will change their interest rates |
Individuals or companies have to shut down their operations | Individuals or companies continue to operate while repaying their debts |
Less expensive compared to chapter 11 | More expensive compared to chapter 7 |
Who Can File for Chapter 11 or Chapter 7?
Chapter 7 bankruptcy is designed for individuals who want to do a “fresh start”. Even organizations can also file for Chapter 7. This form of bankruptcy focuses on removing as many debts as possible and liquidating assets. So, corporations can pay off a variety of remaining debts.
There isn’t any limitation for someone to file either Chapter 11 or Chapter 7 bankruptcy. But, to file for Chapter 7 bankruptcy, he/she needs to pass a “means test” especially when you’re a large amount of unmanageable debt and a low income that hinders debt repayment. Those who have a good and reliable income are less likely to have their Chapter 7 filing approved.
On the other hand, Chapter 11 is a more expensive option than Chapter 7. This is typically designed for medium to large-sized businesses. In addition, smaller businesses and sole proprietors may also want to consider this type of bankruptcy. However, Chapter 11 doesn’t involve liquidating assets. It only restructures the debts. In this way, a debtor can protect their important assets. In the case of sole proprietorships and similarly small businesses, Chapter 11 bankruptcy affects both business and personal assets.
Which One To Choose?
Both Chapter 7 and Chapter 11 bankruptcy have some pros and cons, which depend on the individuals and organizations and how they want to proceed. As we discussed above, the individual file for Chapter 7 can’t run the operation further. The owner needs to liquidate his/her assets as debt payment.
Whereas, Chapter 11 is a reliable option if an individual or a company doesn’t want to shut down their businesses. However, in this case, he/she must show their regular income from operations. So, the court can allow them to run operations and give them some time to repay the debt.
Before filing for bankruptcy, and depending on their own internal legal resources, businesses need to consult with a bankruptcy attorney who specializes in bankruptcy law and discuss any alternatives that are available to them. If you need help in choosing between, consult a bankruptcy attorney in Los Angeles CA. We, at FLP, help you in filing for either Chapter 7 or Chapter 11 bankruptcy. For more information, you can connect with us!