The different types of bankruptcy with their meanings and definitions

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• Bankruptcy is a legal procedure that gives individuals or businesses options when they can’t pay their debts.
• The US bankruptcy code has six types of bankruptcy, each tailored to specific situations. 
• While a bankruptcy filing can provide immediate debt relief, it will hurt your credit for up to 10 years.

If you’re drowning in debt, a few debt relief options may help keep you afloat, such as debt settlements or debt management plans. However, when the best debt settlement services fail to get you out of debt, filing for bankruptcy may be your last resort.

Bankruptcy is a legal process that allows individuals and businesses to resolve outstanding debts owed to creditors while offering them some protection during the process. There are restrictions on the types of bankruptcy you’re allowed to file. How you file depends on whether you are an individual or a business, your level of income, and the kind of debt you have.

How do bankruptcies work?

The purpose of bankruptcy is two-fold. First, it assists creditors in dealing with an insolvent debtor. Second, it allows individuals and businesses a chance to start fresh after a financial downfall. Bankruptcy also can preserve a business’s assets by allowing distressed companies to reorganize rather than liquidate.

“Congress has created courts of specialized jurisdiction — federal bankruptcy courts — to handle such cases in accordance with a statute, the United States Bankruptcy Code, which Congress enacted in 1978,” says Keith Sharfman, professor of law and director of bankruptcy studies at St. John’s University. 

Bankruptcies generally fall into two main categories: liquidations and reorganizations. Liquidation refers to selling off some property to pay for most debts, while reorganizations allow businesses or individuals to restructure their debt and repay it over time.

Businesses or individuals can declare bankruptcy when they cannot repay their debts with their income. When an individual files for bankruptcy, a court decides to either sell off their assets to pay for their debts or to reorganize their debt to make repayment possible. 

Types of bankruptcy filings 

There are six types of bankruptcy, referred to by their chapter in the bankruptcy code. That said, the most common types of bankruptcies are Chapter 7, Chapter 11, and Chapter 13. These are the chapters available to businesses and individuals to file.

Here’s a brief overview of the bankruptcy chapters commonly filed:

Bankruptcy for individuals

Individuals (including self-employed and sole proprietors of businesses) have two options for bankruptcy: Chapter 7 or Chapter 13.

In Chapter 7, nonexempt assets are liquidated to pay off debts. Essential properties, such as your primary residence or even vehicles under a certain value, may be exempt from liquidation. Each state has its own set of exemptions for bankruptcies, so be aware of them when determining what would be considered an exempt asset if you’re considering filing for bankruptcy.

Once those items have been sold off and the proceeds distributed to creditors, the debtor usually receives a discharge on their remaining debts, which means they aren’t on the hook to pay back certain debts after the bankruptcy. Discharge occurs in 99% of individual Chapter 7 cases. 

“For the honest but unfortunate bankruptcy debtor, most debts would be dischargeable to the extent that they can’t be paid off with the assets available to fund an estate in Chapter 7,” says Sharfman. 

As the quickest and, as a result, cheapest bankruptcy to declare, Chapter 7 is the most common bankruptcy filing. It’s a popular option for people declaring medical bankruptcy. That said, Chapter 7 bankruptcy isn’t available to all individuals. 

To qualify for Chapter 7 bankruptcy, you must pass a means test, which consists of two stages. If you can prove that you make less than your state median income, you qualify for Chapter 7. If your income exceeds the state median, you need to subtract your  A means test requires proving that you earn less than the state median current monthly income. If you cannot pass the means test, your case will probably be converted to Chapter 13.

Chapter 13, also called the wage earner’s bankruptcy, is typically used in cases of high-earning individuals. Rather than liquidating assets, Chapter 13 reorganizes debt and creates a repayment plan over three to five years. One advantage of Chapter 13 over Chapter 7 is that debtors may be able to save their homes from foreclosure because they will start a repayment plan.

To be eligible for Chapter 13 bankruptcy, you must owe less than $2,750,000 between your unsecured and secured debts.

Bankruptcy for businesses

Businesses have two main options for filing bankruptcy: Chapter 11 and Chapter 7. 

Chapter 11 bankruptcy is the most common route for businesses going through bankruptcy. Chapter 11 gives businesses an opportunity to restructure their debts and finances while staying operational. If a business cannot successfully manage its finances, its filing converts to Chapter 7, in which it liquidates its assets and ceases to operate. Only individuals can discharge debts. Partnerships and corporations don’t have that right because they can simply stop operating instead.

“Basically, what Chapter 11 does is ask the following question: Is this company more valuable if it continues as a going concern, or is it more valuable to creditors if it’s liquidated?” says Sharfman. 

Other types of bankruptcy

The other types of bankruptcy are less common than those mentioned above. They include:

• Chapter 9: Municipalities like cities, towns, or villages can file for bankruptcy using this type of bankruptcy. Orange County, California, infamously filed for Chapter 9 bankruptcy in 1994.
• Chapter 12: This type of bankruptcy focuses on offering debt relief to family farmers and fishermen.
• Chapter 15: Cross-border cases go under Chapter 15, such as when a US court must recognize and work with a foreign court.

How do I file for bankruptcy?

There are two ways to get into bankruptcy for an individual: by filing a bankruptcy petition voluntarily or through a petition filed by their creditors. While creditors can force an individual debtor into bankruptcy, it’s far more common for them to file a voluntary petition, Sharfman says.

As an individual filing for bankruptcy, you’ll need to complete credit counseling with an approved agency and be able to provide the debt management plan created in counseling. When you submit your bankruptcy petition, you will need to include information on your income, expenses, debts, assets, and any outstanding contracts or leases. 

If you’re filing for Chapter 13 bankruptcy, you must submit a payment plan proposal showing how you will pay off your debts over the next three to five years.

Filing for bankruptcy is a highly complicated process that will require an attorney. 

Advantages and disadvantages of bankruptcy

Bankruptcy is not your only option for getting out of debt. Deciding whether or not to declare bankruptcy requires careful consideration. 

“Anyone thinking about filing for bankruptcy should consider, with the help of competent bankruptcy counsel, both the benefits and the costs,” says Sharfman. The potential consequences include a loss of privacy with the public disclosure of your assets and liabilities, and the inability to file again for a bankruptcy discharge for at least eight years.

Here are some of the main benefits and drawbacks of filing a personal Chapter 7 bankruptcy:

Bankruptcy can be a valuable tool for individuals or corporations struggling with debt they cannot afford to repay. It can provide a fresh start that many need to get back on financial track.

However, bankruptcy is not the best option for everyone. If you are considering filing, understanding the various chapters and requirements described in this article can help you to make sense of the complicated legal process.

Bankruptcy frequently asked questions