Types of Bankruptcies: Which One Is Right for You

When filing for bankruptcy, you’ll have to choose between six different types, depending on your individual situation.

Bankruptcy is a debt relief tool and a legal proceeding you can undertake when you’re unable to repay your debts. The federal courts handle bankruptcy according to the rules of the U.S. Bankruptcy Code.

There are six types of bankruptcy, each servicing an individual or a business. Regardless of the type of bankruptcy you file for, the lasting negative effects will severely impact your credit scores and stay on your credit reports for several years, making it very difficult for you to qualify for new loans and lines of credit during this time.

What Is a Bankruptcy

Bankruptcy is a legal process and often a last financial resort to help alleviate your personal and/or business debts if they become particularly burdensome or overwhelming. You may file for bankruptcy due to job loss, extensive credit card debt, medical bills, divorce, or other financial hardship.

There are six types of bankruptcy chapters: Chapters 7, 9, 11,12, 13, and 15. The U.S. Bankruptcy Code governs bankruptcy cases, and the process looks similar in each state because bankruptcy laws are governed by the uniform federal rules of bankruptcy procedure.

The Impact of Bankruptcy

Declaring bankruptcy can relieve you from your obligation to repay debts and provide you with a fresh financial start, depending on the type of bankruptcy you file for. Different types of bankruptcies will also lower your credit score by varying degrees and will make it difficult for you to rent an apartment and get a credit card or a loan, especially in the first 3-4 years after your bankruptcy is discharged.

Chapter 7, for example, stays on your credit report for ten years, and Chapter 13 stays there for a minimum of seven years. If you were to apply for a loan during this time, creditors can see the bankruptcy discharge on your credit report and may decide not to provide credit, based on evidence of recent financial difficulty. 

You may also be subject to higher interest rates and reduced–or even closed–revolving credit line accounts after filing. Until your credit scores recover in the years following, you will have to find other methods of financing purchases, such as using cash savings or borrowing from friends and family. 

How Bankruptcy Works

You’ll first need to submit a petition to the federal bankruptcy court to begin the bankruptcy process. Your petition will include several forms and documents related to your financial situation, such as your tax returns, bank statements, and income documents. Additionally,  you’ll have to attend a credit counseling course and a debtor education course, which is a mandatory requirement for properly filing for bankruptcy.

After filing the petition, you’ll be required to attend a 341(a) meeting of creditors with a court-appointed trustee to answer questions about your financial situation and ability to repay your debts. Once you file for bankruptcy, you’ll receive immediate relief from collection calls and letters, through an automatic stay. 

Once the bankruptcy process is complete, you’ll receive a discharge. A bankruptcy discharge is a court order that permanently releases an individual or business from specific debts and obligations they owe to creditors. 

What Are the Different Types of Bankruptcy?

The three types of bankruptcies most commonly used by individuals and businesses are Chapters 7, 11, and 13. Family farmers and fishermen use Chapter 12.

Chapter 7 Bankruptcy

Among the different types of bankruptcy, Chapter 7 is the most commonly used and well-known. Chapter 7 is known as liquidation bankruptcy since it allows you to liquidate your non-exempt assets and resolve most types of secured and unsecured debts.

You must pass a “means test” which compares a debtor's income for the previous six months to what he or she owes on debts, to qualify for Chapter 7. It is important to note, however, that not all of your debts will be discharged. You’ll still be liable to pay tax debt, alimony, and child support.

Pros and Cons

Here’s a look at the advantages and disadvantages of filing for Chapter 7 bankruptcy.

Pros

• It offers you a fresh financial start.
• You may still be able to retain exempt assets.
• The automatic stay will immediately stop collection calls, liens, and wage garnishment.
• Chapter 7 can discharge most unsecured debts.

Cons

• Chapter 7 will remain on your credit report for up to ten years.
• It will be quite difficult for you to get new credit in the years following your bankruptcy.
• You’ll have to give up non-exempt assets.
• It won’t eliminate tax debt, child support, student loan debt, or alimony.

When To Choose a Chapter 7 Bankruptcy

Chapter 7 bankruptcy may be right for you if you are an individual or business with a lot of unsecured debts. It’s also suitable for those who can pass the means test.

Chapter 11 Bankruptcy

Chapter 11 bankruptcy is a type of reorganization bankruptcy. It allows businesses, and individuals who are sole proprietors, to submit a plan to repay some of their debts while retaining their assets. Businesses filing for Chapter 11 don’t put their shareholders’ personal assets at risk because the business is a separate entity, but the value of a business’ shareholder equity is most often reduced significantly, until the company can recover financially.

For a sole proprietorship, the debtor and owner are the same person, so the court will consider business and personal assets in the filing.

Pros and Cons

Chapter 11 bankruptcy may be a suitable option for businesses and, in some cases, individuals, but it’s important to weigh the pros and cons.

Pros

• Businesses can continue operations while debt is restructured.
• You’ll be able to repay creditors over time.
• Chapter 11 cases usually don’t have a trustee.The person or entity who files for bankruptcy will be the “debtor in possession” of the business’ assets and acts as the bankruptcy trustee.
• Individuals and sole proprietors with debts that exceed the Chapter 13 bankruptcy debt limits may file for Chapter 11 instead.
• Can sometimes be less expensive than Chapter 13, which is a type of debt reorganization bankruptcy.

Cons

• Chapter 11 can be complex, expensive, and lengthy compared to other types of bankruptcy.  The typical length of time in Chapter 11 is 5 years.
• The filing fees are expensive at $1,738, and attorney fees can be $15,000 to $30,000.
• The repayment plan will only be approved when a majority of lenders vote for it.
• If the business is closely-held by just a few owners, personal assets may not be entirely protected.

When To Choose a Chapter 11 Bankruptcy

Chapter 11 can be complicated and expensive, so it is not usually feasible for individuals. If you're considering bankruptcy, comparing Chapter 11 vs 7 can be a good idea.

If you’re a partnership, LLC, or corporation, it may be a suitable option for you.

Chapter 12 Bankruptcy

Chapter 12 bankruptcy allows fishermen and family farmers to reorganize their debt. Farmers that don’t meet the wage-earner classification and have larger debts can opt for Chapter 12. The repayment period is usually three years, but the court can extend it up to five years.

Once the repayment obligations under the reorganization plan are fulfilled, the court will discharge your debts. Chapter 12 bankruptcy doesn’t discharge certain debts, such as alimony and child support.

Pros and Cons

Here are the benefits and drawbacks of filing for Chapter 12 bankruptcy.

Pros

• No credit counseling or means test requirements.
• Assets are not at risk of forfeiture or foreclosure.
• You have up to 90 days to file the repayment plan.
• Monthly payments don’t need to be equal and can accommodate seasonal earning trends.

Cons

• If you fail to make the required payments, the court will dismiss your case, and you will have to wait a certain amount of time before you can re-submit an entirely new Chapter 12 bankruptcy petition.
• It’s only available to fishermen and farmers with regular income.
• The plan needs to be approved by the bankruptcy court and your creditors.

When To Choose a Chapter 12 Bankruptcy

Chapter 12 bankruptcy may be right for you if you are a fisherman or farmer with a regular income. You must also not have the ability to make current monthly payments, as stated in your initial repayment plan.  

Chapter 13 Bankruptcy

Chapter 13 bankruptcy helps individuals restructure their debts. This type of bankruptcy is not available to businesses. There are debt thresholds that may restrict eligibility for Chapter 13. For example, as of 2023, you can’t have more than $2,750,000 in unsecured and secured debts combined.

The repayment period in Chapter 13 bankruptcy lasts from three to five years. A major benefit is that your home is not at risk during the proceedings.

Pros and Cons

Before filing for Chapter 13, consider these pros and cons.

Pros

• There’ll be an automatic stay of creditor collection calls and letters, as soon as you file for bankruptcy.
• It may allow you to avoid foreclosure by giving you time to catch up with payments.
• Unless the bankruptcy court authorizes it, lenders can’t collect from co-signers.
• It allows you to make a single payment every month, which will be distributed to your lenders.
• You don’t need to pass the means test to qualify.

Cons

• Chapter 13 bankruptcy remains on your credit reports for a minimum of seven years.
• Your credit scores can drop substantially once you file the petition.
• It may be very difficult to qualify for new credit or get a new apartment lease in the first few years of your Chapter 13 bankruptcy filing.
• If you fail to make the monthly payment, the court can dismiss your bankruptcy case and you will have to wait a certain period of time before you can submit a new Chapter 13 bankruptcy petition.

When To Choose a Chapter 13 Bankruptcy

Compared to Chapter 11, Chapter 13 may be suitable for you if you have a regular income and the ability to make a monthly payment as specified in your payment plan. You’ll only get a discharge once you complete your 3-5-year repayment plan. If you need your debts discharged sooner, Chapter 7 may be the better option.

According to Brad Reichert, debt expert and founder and managing director of Reichert Asset Management LLC, both Chapter 13 and Chapter 11 bankruptcy benefit businesses in different ways. 

“The primary benefit of Chapter 11 for partnerships, LLCs, and corporations is to give the business’ managers some time to get their financial house in order and back to profitability,” Reichert explains. “Also, the main difference between Chapter 11 and Chapter 13 bankruptcy is the debt limits that an individual or sole proprietor business owner may have to qualify for,” Reichert adds.

Which One Is Right for You?

Bankruptcy is a complex process and often a last resort option, so it’s best to consult with a bankruptcy lawyer to determine if it’s right for you. Your bankruptcy attorney can also educate you about the different types of bankruptcy and which one may be suitable for your unique situation.

Regardless of the type of bankruptcy you file, not all debt may be discharged. You’ll still need to repay tax debts, as well as past-due alimony and child support, if you owe them. Here’s a side-by-side comparison of the four types of bankruptcies we discussed above so you can see which one may be right for your individual situation.