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If you or your business is struggling financially, bankruptcy can be a last resort to provide financial protection and potentially a fresh start. With different bankruptcy options available, it's important to understand your situation to determine the correct path for you.
Here are the types of personal and business bankruptcies and how they work.
Types of Personal Bankruptcies
If you're drowning in consumer debt, you may be able to liquidate or reorganize certain debts and obtain relief. Keep in mind that certain types of debt cannot be included in a personal bankruptcy. That includes alimony and child support, certain taxes and loans made or guaranteed by the government, among others.
Chapter 7 Bankruptcy: Liquidation
Chapter 7 bankruptcy involves the liquidation of certain assets to pay off what you can of your debt, after which the remainder is discharged. The types of assets that are exempt can vary by state, but they generally include things like your clothing, home furnishings, retirement accounts and a portion of your vehicle or home.
To qualify for Chapter 7 bankruptcy, your current monthly income must be below your state's median income, or you must pass a means test to prove that your disposable income is insufficient to pay your debts.
If you're eligible, the court will assign a trustee to handle the liquidation of your assets to pay your creditors. The full process takes roughly four to six months, but the public record will remain on your credit reports for 10 years from the filing date.
Chapter 13 Bankruptcy: Reorganization
If you don't qualify for Chapter 7 bankruptcy, or you want to minimize the negative impact on your credit score, you may consider Chapter 13 bankruptcy. With this option, the court reorganizes your debt, allowing you to make full or partial payment over three to five years. Any remaining debt will be discharged.
You don't need to pass a means test to qualify for Chapter 13 bankruptcy—anyone with less than $2.75 million in total debt is eligible. However, there is a means test to determine the length of your repayment plan and monthly payment.
Once you come to an agreement on the terms, you'll make your payments to a trustee, who will distribute the funds to your creditors. While this type of bankruptcy takes longer, it only remains on your credit reports for seven years from the filing date.
Types of Business Bankruptcies
If you're the owner of a corporation, partnership or sole proprietorship, there are three different options for obtaining relief from your business debts.
Unless you're a sole proprietor or you've signed a personal guarantee, filing for business bankruptcy typically doesn't damage your personal credit. The impact of a business bankruptcy on your business credit history can vary depending on the business's credit score.
Chapter 7 Bankruptcy: Liquidation
Chapter 7 bankruptcy works similarly for businesses as it does for individuals. The primary difference is that businesses that file for liquidation bankruptcy must cease operations. This option is available to sole proprietors, partnerships and corporations. Businesses are exempt from the personal means test.
In addition to liquidating your assets for payment to your creditors, the trustee may be authorized to continue operating the business for a limited period if the court determines that it will benefit your creditors.
Chapter 11 Bankruptcy: Business Reorganization
Chapter 11 bankruptcy allows the filing business to continue operations while it restructures its debts and other obligations with the court's assistance.
That said, certain activities, such as selling assets outside of the normal course of business and taking on new debt, typically require court approval.
Individuals with significant amounts of debt who don't qualify for other personal bankruptcies may also be eligible for this option. In that case, the public record will remain on your credit report for seven years from the filing date.
Chapter 13 Bankruptcy: Reorganization
As with Chapter 7, Chapter 13 bankruptcy works the same for small businesses as it does for individuals. That said, this option is only available to sole proprietors, in which case there's no line between personal and business debts.
Your debts will be reorganized based on your income and ability to pay, and any debt you don't pay after three to five years will be canceled.
Other Types of Bankruptcy
There are three specialized types of bankruptcy for certain situations that aren't addressed in other bankruptcy codes. Here's a quick summary of how they work and who's eligible.
- Chapter 9 bankruptcy: This option is designed for municipalities, including towns, cities, villages, counties, school districts, municipal utilities and taxing districts. It provides protection while the municipality negotiates an adjustment of its debts, which typically includes extending debt maturities, reducing principal and interest or refinancing the amount owed.
- Chapter 12 bankruptcy: This type of bankruptcy is available to family farmers and family fishermen with regular annual income. Like Chapter 13 bankruptcy, Chapter 12 allows eligible filers to reorganize their debts and pay them in full or part over three to five years while remaining in operation. Any remaining eligible debt will be discharged.
- Chapter 15 bankruptcy: This type of bankruptcy is essentially a recognition of a bankruptcy filed in a foreign country. This ancillary proceeding promotes cooperation between U.S. and foreign courts, particularly when a foreign bankruptcy involves financial interests in the U.S.
Is Filing for Bankruptcy Right for You?
Whether you're a business owner or an individual, filing for bankruptcy can provide some relief from burdensome debts. That said, the decision can have a significant negative impact on your personal or business credit score—or, in some cases, both.
Before you file for bankruptcy, consult with a bankruptcy attorney who can help you evaluate your options and advise you on your options. If you're an individual, you can also consider working with a credit counselor who can discuss other options, such as debt consolidation, accelerated debt repayment strategies or a debt management plan.
If you choose to go through with bankruptcy, be sure to monitor your credit throughout the process and after your discharge to understand how the process impacts your credit score. You can also track your progress as you take steps to rebuild your credit after bankruptcy.
