A recent publication by the American Bankruptcy Institute reported an increase in bankruptcy filings at the start of 2023. Filings for all chapters increased by 19% last January compared to January 2022. Individual filings shot up by 20%, whereas business filings were 12% higher, with 70% of those for Chapter 11 bankruptcy.
Bankruptcy can be good or bad, depending on how you view it. Nevertheless, it has played a critical role in the financial system for centuries, enabling individuals and businesses to settle crippling debts. A bankruptcy attorney will recommend this option when all other avenues of debt settlement have been exhausted.
Considering more people and business owners filing for bankruptcy, now’s a good time to go over U.S. bankruptcy law. Specifically, this review will discuss the different chapters in detail.
The Bankruptcy Code
Everyone refers to bankruptcy by chapters because that’s what the law calls them, namely Title 11 of the U.S. Code or the Bankruptcy Code. It contains nine chapters that are all odd numbers save for Chapter 12. Legal experts believe lawmakers set it up this way to accommodate future chapters (although the latest addition was classified as Chapter 15).
The first three chapters describe how the legal system handles a bankruptcy case, from general provisions to the responsibilities of the involved parties. However, the public is more familiar with the six following chapters, as they detail the approach to debt settlement.
Chapter 7 bankruptcy is also referred to as liquidation of assets. In this approach, a trustee gathers a debtor’s non-exempt assets and sells them to pay the creditors. Non-exempt assets vary by state law, but they typically include retirement accounts, professional or trade tools, and vehicle equity, among other things.
Chapter 7 applies to both individuals and businesses. However, business owners rarely file for liquidation because Chapter 11 bankruptcy allows them to continue operations without selling most of their assets.
Unless you’re a municipality, there’s no need to be overly concerned about this. As Chapter 7 doesn’t provide a mechanism for liquidating a municipality’s assets, Chapter 9 bankruptcy involves renegotiating a payment plan with the municipality’s creditors. The chapter doesn’t apply to states, as the Bankruptcy Code doesn’t allow them to declare bankruptcy.
More commonly known as reorganization, Chapter 11 bankruptcy allows debtors to keep their assets by restructuring their debt. As mentioned earlier, this arrangement allows the debtor, mainly business owners, to keep crucial business assets while their creditors gradually get their money back.
While Chapter 11 provides excellent benefits, it’s also the lengthiest and most complicated process. Experts estimate that such a case can receive approval after one or two years of filing. The duration of a typical Chapter 11 bankruptcy prompted lawmakers to introduce Subchapter V in Chapter 11 in 2020, expediting the process for small businesses.
Chapter 12 also involves reorganization but is designed for individual or company-owned farms and fisheries. Initially introduced as a stopgap response to a debt crisis plaguing the farming sector in the 1980s, it became a permanent fixture of the Bankruptcy Code in 2005.
This chapter is a less expensive alternative to Chapter 11, considering that most farming and fishing owners can’t afford the high legal costs that typically come with Chapter 11. It’s also an alternative to Chapter 13, seeing that their usual debts are too big to qualify for such.
This chapter is also known as a wage earner’s bankruptcy, designed for people whose income can’t surmount their debts. It consolidates all debts into one amount, which the debtor pays in an agreed-upon monthly plan. Instead of going directly to creditors, the payments go to the trustee, who then distributes them to the creditors.
The downside is that it limits how much debt can be consolidated. It used to uphold separate limits for secured and unsecured debts. But after President Joe Biden signed the Bankruptcy Threshold Adjustment and Technical Corrections Act into law on June 2022, the limit was unified to a collective amount of USD$2.75 million.
At the recommendation of the United Nations to manage cross-border insolvency, the U.S. added Chapter 15 in 2005 under the Bankruptcy Abuse Prevention and Consumer Protection Act. Simply put, U.S. courts can work with courts in other countries where debtors, creditors, and assets are involved in insolvency cases.
As bankruptcy essentially involves forgiving some debt, it isn’t unusual for people to see it as a more favorable way to get out of debt. Creditors would want to see every penny paid back—and allowing everyone to file for bankruptcy without resorting to other options isn’t ideal for them.
For Chapters 7 and 13, the legal system mandates means-testing to assess the debtor’s ability to pay their debts. It compares the debtor’s average monthly household income (at least half a year before filing) with the state average. Passing the test makes the debtor eligible for Chapter 7, but failing it doesn’t mean they’re ineligible for filing for bankruptcy. They can wait six months for a reassessment or file for Chapter 13.
Filing for bankruptcy, whether as an individual or business owner, shouldn’t be taken lightly. It’s reserved for situations where debt restructuring and consolidation are not enough to meet financial obligations. Filing for bankruptcy protects an individual or business from legal action and can even help preserve important assets in the process.
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