In the United States, firms, individuals, and married couples are all eligible to file for bankruptcy, if they fail to meet their debt commitments. There are four filings in the Fed Bankruptcy Code such as Chapter 7, Chapter 11, Chapter 12, and Chapter 13.
Chapter 7 stands for liquidation and Chapter 11 represents rehabilitation or reorganization bankruptcy, while Chapter 12 states adjustment of debit of a family grower with regular earnings and Chapter 13 illustrates the adjustment of debts of an individual with regular annual income. The main difference between chapter 7 vs chapter 11 is that under Chapter 11, the debtor negotiates with lenders to change the terms of loan without needing to sell off properties, whereas in Chapter 7, debtor’s properties are sold off to pay the creditors.
Features of Chapter 7 and Chapter 11
Sometimes, Chapter 7 is called ‘liquidation bankruptcy’ and companies facing this type of economic failure must sell off their possessions to pay the lenders. Here, creditors or lenders collect their payments by auctioning the belongings. An appointed trustee makes sure that any item that is secured is sold and that the proceeds are paid to the respective lenders. For instance, secured arrears would be loans given by financial institutions or banks based upon the value of a specific property. Whatever residual cash and assets remain after all secured creditors are paid off, are puttogether to be paid to any outstanding lender with unsecured mortgages, such as preferred shareholders, and bondholders.
Chapter 11 is also referred to as rehabilitation bankruptcy; it givesan opportunity to the companies to rearrange their debt payments, and come out of financial troubles. It is much more involved than the chapter 7 bankruptcies and here, companies will contact its lenders in an attempt to modifythe term on loans, like dollar value of payments and interest rates. As in case of Chapter 7, it needs a trustee and here, rather than selling all the things, the trustee checks the assets of the nonpayer, allowing the debtor to continue the business. Here, debt is not absolved and reorganizing only changes the terms of the loan and the company is allowed to pay it back through future incomes, but in a more relaxed way.
How Are Creditors Paid?
For the debtor, chapter 7 bankruptcy is a fresh start, with a clean fiscal slate. After the debtor files for bankruptcy under this Chapter, the appointed trustee sells the assets. Federal and state laws consider specific asset free from confiscation, like personal things (clothing) and debtor’s primary residence. Once the assets are liquidated, the trustee pays certain lenders a portion of the price. Lenders with secured debt or loans are paid first when the properties are sold off.
Chapter 11 is Mainly Meant for Companies but Individuals Can File Too
When Chapter 11 was formulated, it was designed only for large companies; but, now individuals are allowed to file for bankruptcy under this law. A trustee would be handling the bankruptcy and he’d work together with debtor to form a repayment plan, considering outstanding loans. Here, only the terms of debt and loan are modified so that it would be easier for the debtor to make the payment.
Filing for bankruptcy isn’t to be taken very lightly and it does affect your credit ratings for several years. The decision to file for bankruptcy is best made under a legal representative or financial planner, and one should make a move only after contemplating all the pros and cons.
Lisa Siegel is a legal expert, who helps individuals with debt problems and bankruptcy issues for a debt-free future. He often writes comparisons like benefits of filing under chapter 7 vs. chapter 11 of bankruptcy.