The Differences Between Each Type of Bankruptcyby
Most people are familiar with Chapter 11 and Chapter 13 bankruptcy, but those aren't the only types. The correct one to file for actually depends on the type of client you're dealing with and whether they're a small business owner or an individual, a town or city representative, or a member of an international business. In his final post of 2020, financial guru Bryce Sanders explains the differences between the types.
No accounting professional wants to tell their client to give up. Some clients might remind you of the expression: “Why does someone bang their head against the wall?” Because it feels so good when you stop. In many cases, bankruptcy isn’t the final chapter. It’s an opportunity to draw a line, reach a conclusion and get a fresh start. Creditors don’t like that, but clients do.
Your clients are moral people. They feel responsibility for their debts. They also want to provide for their family. Meanwhile, creditors are making their lives miserable and want to seize everything they can. Under certain circumstances bankruptcy can be the middle ground, not the end point.
One of the main attractions of the bankruptcy process is the ability to start over. You and a bankruptcy attorney help them navigate the process. Once they have fulfilled their obligations, the bankruptcy is discharged. It’s behind them. They can start to rebuild their life.
Numbers You Need to Know: 7, 9, 11, 12, 13 and 15
You didn’t think this was going to be simple, did you? The acronym “A SKIRT” represents the six types, 12-7-13-15-11-9. We will examine each, but out of order.
Chapter 7: “S” is for Shut
This definition is most people’s conception of bankruptcy. When you play Monopoly and run out of money, you are unable to pay your debts and lose your remaining cash, houses and hotels.
The objective is to close a business. Operations cease. If you are an individual, you have a very low income. Everything gets sold to pay creditors. The business is closed.
Advantages: here is a court stay placed on your creditors. They stop chasing you. Any remaining debt is wiped out after assets are sold.
Disadvantage: Creditors can take everything except exempt property. Rules vary by state. If your home equity is greater than the homestead exemption, you stay. If it is less, the mortgage holder can sell your home and give you the cash value of the homestead exemption.
Chapter 13: “K” is for Keep
This version is the solution most people who owe money hope to receive. This version is only available to individuals, not businesses. It’s more suited for people with high incomes, significant assets and significant debts. The general idea is you keep almost everything in exchange for committing to a plan to apply your discretionary income to debt repayment. You don’t need to pay off all the debt, the bigger issue is everything that can go towards debt reduction does flow in that direction.
The objective is for an individual to gain breathing space while retaining property they own.
Advantages: You can keep most of your property. Continue earning money. Priority and secured debt must be paid, but you can get relief from unsecured debt.
Disadvantages: s with all chapters of bankruptcy, there are certain debts that don’t go away. Examples are child support and alimony. Although you are allowed to keep your property, you must be able to afford it. Non-exempt property is sold.
Chapter 11: “R” is for Restructure
This type of bankruptcy is often used in the business world. (It can be used by individuals, too.) It allows a business to reorganize and keep operating as a going concern. Nieman Marcus, J. Crew and Pier 1 are some of 2020’s high-profile Chapter 11 bankruptcies. On the positive side, years ago, General Motors and United Airlines entered and emerged from Chapter 11. It’s expensive.
The business submits a reorganization plan to the court, addressing it’s debts. It must treat creditors fairly. If the company doesn’t submit a plan, the creditors can put one forward. The company may choose to sell off divisions or brands to raise money to satisfy creditors. The object is for the company to emerge from bankruptcy.
Advantages: The company gets breathing space. The business still operates. People keep their jobs. There’s a plan in place and light at the end of the tunnel.
Disadvantages: The company cannot make all it’s own decisions, especially in areas like union negotiations, expanding or signing leases. Courts are involved. Creditors must agree to the reorganization plan.
Chapter 15: “I” is for International
Many companies operate abroad. They are subject to the laws of the countries where they operate. Chapter 15 represents a team effort where different jurisdictions cooperate. It’s patterned after the “Model Law on International Commercial Arbitration.” Eighty countries are signatories. It’s been around since 1978. This version of the international bankruptcy code brings foreign creditors into the US court system to make their case.
Advantages: It gives foreign creditors standing in a case within the US courts. US creditors have standing in foreign courts.
Disadvantages: None. It’s procedural to see creditors aren’t ignored.
Chapter 9: “T” is for Town
Municipalities can also get into financial trouble. Chapter 9 bankruptcies are unique to counties, cities and towns. School districts can file too, but not states. These rules protect assets. Properties cannot be liquidated to pay debts, for example. In the municipal bond world, General Obligation bonds are backed by taxing power. Revenue bonds are backed by the operation of certain assets, like toll roads. Moral obligation bonds are similar to unsecured debt.
The municipality must have a plan approved that would negotiate repayment of debts owed. Returning to the example of municipal bonds, solutions might include extending maturity dates, reducing the interest rate or ev en the principal amount.
Advantages: The municipality is allowed to renegotiate it’s debt. Assets like buildings cannot be forcibly sold or seized.
Disadvantages: There may be an unelected oversight authority put in place
Chapter 12: “A” is for Agriculture
There’s a special category of bankruptcy specific to farms and the fisheries. There are similarities to Chapter 13 concerning asset protection. 50% or more of the filer’s income must come from farms or fisheries. Since this involves individuals, 50% of their debt must come from operation of the business, not personal debt like a home mortgage. The objective is the farmer can continue operating their business.This version was introduced in 1986.
Advantages: Creditors cannot chase after a consumer’s debt either. The farmer or fisheries own can continue operation. They are restructuring their debt.
Disadvantages: The farm or fishery must be the person’s primary source of income. There are debt relief limits. Same assets can be used to repay debts.
Most accounting professionals will be advising their clients within the scope of Chapters 7, 11 or 13.
Bryce Sanders is president of Perceptive Business Solutions Inc. in New Hope, Pennsylvania. He provides high-net-worth client acquisition training for the financial services industry. His book, Captivating the Wealthy Investor, can be found on Amazon.com.