When a business or individual no longer has the financial resources to make good on debts, some protection is afforded through U.S. bankruptcy law. Filing for bankruptcy can mean that all qualified assets are liquidated in order to pay bills, as in Chapter 7 bankruptcy, or that accompany goes through a financial restructuring which allows it to pay off all outstanding debt while being afforded some protection against creditors. The latter of the two describes Chapter 11 bankruptcy law.
In the United States there are six different chapters in the federal code under which an individual or business can file bankruptcy. They are as follows:
- Chapter 7 - a total liquidation of assets to pay off creditors; can be used by individuals or businesses.
- Chapter 9 - a total liquidation or reorganization reserved for use by municipalities and government institutions.
- Chapter 11 - a reorganization plan allowing ownership of assets to be retained while paying off debts; can be used by individuals or businesses.
- Chapter 12 - a special bankruptcy proceeding reserved for family farms and fishing businesses.
- Chapter 13 - a reorganization plan designed for private individuals.
- Chapter 15 - a special bankruptcy plan reserved for insolvencies involving foreign entities.
Initiating Chapter 11 Bankruptcy
When a company or individual finds itself in a position of severe distress, relief can be found in filing for Chapter 11 bankruptcy protection. Once the proceeding has begun creditors are barred from continuing collection efforts on any qualifying debts covered under the reorganization plan. The bankruptcy court must approve a reorganization plan before it is implemented, and it must provide for the settlement of all qualified debts within 3 to 5 years. Although a reorganization plan is approved by a court, it is developed by the individual or business in conjunction with a bankruptcy attorney.
What many people don't realize is that Chapter 11 bankruptcy laws allow creditors to force a bankruptcy proceeding on a business in distress. Creditors may do so in order to force a company to be fiscally responsible. Sometimes this is a creditor's only option to recover money owed by a business in distress. Most reorganization plans will not be approved unless it can be demonstrated that the individual or business filing the plan has the means to make good on it. Therefore, when a reorganization plan is approved it greatly increases the chances that a creditor will eventually be paid.
Chapter 11 Bankruptcy Does Not Eliminate Debt
The major difference between a reorganization and a liquidation is the fact that under Chapter 11 bankruptcy debts are not eliminated. Creditors may negotiate a lower settlement cost than what is actually owed, but at least something will have to be paid on all debts. Furthermore, some things are not covered under bankruptcy such as tax liens, mortgages, and vehicle loans. If a company is behind on a mortgage when bankruptcy is filed, it will be protected against foreclosure only during the bankruptcy period. Once the bankruptcy is concluded, real estate may still be foreclosed upon if the company has not brought payments current.
When Chapter 11 bankruptcy is utilized by sole proprietors, it does not cover individual debts like unpaid alimony and child support, personal tax liens, mortgages, auto loans, student loans, and debts incurred after the bankruptcy proceeding was started. All of those debts are still the responsibility of the individual regardless of the outcome of the bankruptcy. It is this one aspect that surprises most individuals who expect bankruptcy will give them a clean slate. It does not.
Chapter 11 Bankruptcy for Individuals
While Chapter 11 bankruptcy laws indicate that private individuals can file under this designation, it is very rarely used in this manner. That's because Chapter 11 makes a clear distinction between personal assets and business assets. For private individuals with very little business holdings, that distinction is very difficult to make. Therefore, most private individuals seeking reorganization will file under Chapter 13 instead. Individuals who choose Chapter 11 will have some extenuating circumstances to contend with, such as investment income or real estate holdings.
Both the U.S. bankruptcy court and bankruptcy attorneys suggest that seeking protection in this manner should be used only as a last resort. Where individuals are concerned, the law generally requires consumer credit counseling and debt settlement services be attempted before filing for bankruptcy. In any case, you should seek the advice of an attorney before beginning this process.