Chapter 11 vs. Chapter 7 Bankruptcy: Which One to Choose?

Chapter 11 and Chapter 7 are two common types of bankruptcy. Individuals and businesses can use Chapter 7 bankruptcy to liquidate their assets and use the proceeds to repay creditors. The remaining debt after liquidation is usually forgiven.

Chapter 11 bankruptcy is generally used by businesses but can also be used by certain individuals, e.g. sole proprietors. With this type of bankruptcy, your debts will be restructured, and you’ll be required to repay them over time to keep your business viable.

Understanding the key differences between Chapter 11 vs. Chapter 7 bankruptcy will help you understand how each works and which one is right for you.

Differences Between Chapter 7 and Chapter 11 Bankruptcy

Chapter 11 bankruptcy is intended for larger bankruptcy cases, making it expensive and complicated. Businesses with a large debt load usually choose to file for Chapter 11 bankruptcy vs. Chapter 7. Individuals may choose to file for Chapter 11 bankruptcy if they have too much debt to qualify for Chapter 13 bankruptcy.

The key difference between the two types of bankruptcy is that in Chapter 11, debt is restructured, so you’ll still need to pay it back over time. In Chapter 7, the court-appointed trustee will liquidate your assets to pay back your creditors.

Eligibility Requirements

It’s easier to qualify for Chapter 11 vs. Chapter 7, mainly due to  Chapter 7 means test requirement. You’ll only be able to file for Chapter 7 if you pass the means test, which measures your income in relation to your state’s median income, and compares that to the amount of your monthly debt payments.

Another qualification requirement for Chapter 7 bankruptcy is that you must not have filed for a Chapter 13 case in the last six years or a Chapter 7 case in the last eight years.

To qualify for Chapter 11 bankruptcy, you should be an individual, partnership, LLC, or other corporation. There’s no income requirement or debt limit to qualify for Chapter 11 bankruptcy. However, because Chapter 11 cases can be expensive, time-consuming, and complex, it may not be the best choice for everyone.

Financial Implications

For businesses, Chapter 7 bankruptcy is usually the final step when their business is failing, and on the brink of closure. Chapter 7 offers the protection of an automatic stay of collection attempts such as calls and letters, while they’re in the process of liquidation. Business operations do not continue after Chapter 7 bankruptcy. The main difference between Chapter 11 vs. Chapter 7 is that with Chapter 11, a business can continue operating while it’s reorganizing its debt structure.

Chapter 7 filers may be able to get thousands in unsecured debts discharged (or, in other words, eliminated) without committing to a repayment plan. Creditors are paid if you have non-exempt property that the trustee can liquidate. Chapter 11 bankruptcy requires you to commit your disposable income to a payment plan.

What Is Chapter 7 Bankruptcy

Chapter 7 bankruptcy is also called liquidation or straight bankruptcy. Individuals and small business owners who earn low incomes and can pass the means test can qualify to file for Chapter 7. Once you file for bankruptcy, a trustee will liquidate your non-exempt assets to pay what you owe.  

Non-exempt assets include musical instruments, collectibles like art and coins, family heirlooms of any significant value, all liquid assets like bank and investment accounts, as well as a second vehicle or second home.

If you have a lot of debt, such as medical bills, personal loans, credit card debt, the court can discharge it when you file Chapter 7. You’ll still be liable for certain responsibilities, such as student loans, alimony, taxes, and child support.

Pros

• You’ll be relieved of most, if not all, your debts.
• There are no maximum debt limits that would prevent you from filing.
• You’ll get an opportunity for a fresh start, after your bankruptcy is discharged.
• The automatic stay will stop collection efforts.
• You may be able to catch up with mortgages and avoid foreclosure.

Cons

• You’ll have to give up your non-exempt assets.
• It’s difficult to pass the means test.
• Bankruptcy will remain on your credit report for up to ten years after your bankruptcy is discharged.
• It’ll be very difficult to get new credit after bankruptcy, especially in the first 3-5 years after it is discharged.   

What Is Chapter 11 Bankruptcy?

Chapter 11 allows businesses and individuals to reorganize their debts so they can continue business operations while repaying their creditors. The bankruptcy laws under Chapter 11 also provide businesses the opportunity to renegotiate the terms of their debts, such as payment amounts and interest rates.

Most people file for Chapter 11 when their debt is over the allowable limit to qualify for Chapter 13 bankruptcy (which is $2.75 million, as of 2023). Once you submit your payment plan, a majority of your creditors must approve it for the court to accept it.

Pros 

• You’ll be able to renegotiate loan terms.
• You can continue business operations.
• The automatic stay will stop all collection efforts.

Cons

• Chapter 11 bankruptcy process may take up to five years.
• You’ll have to commit to a long-term payment plan.
• A majority of creditors have to approve the reorganization plan in order for you to move forward.
• Chapter 11 can be complex and expensive.  

When To File for Chapter 7

Most small businesses file for Chapter 7 bankruptcy when they’re past the stage of reorganization. If your business debt is so high and your income has been reduced so low that there’s no way for you to repay it, Chapter 7 bankruptcy is the last resort. The process works the same for individuals.

You’ll no longer be able to continue your business once you file for Chapter 7 bankruptcy, so most businesses consider Chapter 11 as a first step toward a workable solution. If Chapter 11 or Chapter 13 fails, you can file for Chapter 7 to sell your assets, pay your creditors, and start over again.

When To File for Chapter 11

If your business is still profitable and you would like to continue operating it, Chapter 11 bankruptcy filing provides you the opportunity to propose a payment plan to the bankruptcy court. This will allow you to reorganize the business operations and financial affairs of your business, and get it back to sufficient profitability to support your business debts.

Any kind of business bankruptcy, like Chapter 11, can be complex and time-consuming and usually involves a large amount of attorney’s fees, especially if the process lasts 5 years or more. Chapter 11 is generally used when you don’t qualify for Chapter 13 due to a larger debt load.

Which One Is Right for You?

The right type of bankruptcy between Chapter 11 vs. Chapter 7 will depend on your individual circumstances and financial situation. If you have too much unsecured debt and your income can’t keep up with repayment, Chapter 7 may be a better option.

If you want to protect your assets and have reliable income, Chapter 11 may be a good choice. Chapter 11 may also be a good option for businesses that want to continue operations while restructuring their debts.

Brad Reichert, a debt expert and the founder and managing director of Reichert Asset Management LLC, believes businesses can benefit from filing Chapter 11. “Several major companies in the U.S. have used Chapter 11 bankruptcy to restructure and re-emerge into profitability successfully,” Reichert explains. “Some firms experienced financial difficulty but are now back to being industry leaders,” he adds. 

Reichert says that “although bankruptcy of any kind is not guaranteed to solve a particular solution, Chapter 11 reorganization can be used as a potential way to gain some more time to turn things around financially, instead of filing Chapter 7.”  

The best way to determine the right option is to consult a bankruptcy lawyer. Most bankruptcy attorneys will offer a free initial consultation, where you’d be able to ask questions and seek legal guidance about your case.