What Are the Types of Bankruptcies?
Bankruptcy is usually a difficult situation for all involved. Obviously the debtor is under a crushing burden of indebtedness, but the creditors are hurting, too--they put up their money or goods and just want to be paid as agreed. Bankruptcy is the process of resolving these issues, often through compromise, for the benefit of all involved. But, every situation is a little different, and there are different kinds of debtors. Thus, there are different types of bankruptcies to address just about any conditions.
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Types
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There are five common types of bankruptcy, most of which are determined by the nature of the debtor. Chapter 7, for both businesses and individuals, is liquidation. Assets will be sold off to pay creditors, but any remaining debts are forgiven. Restructuring is done under Chapter 11 for businesses or Chapter 13 for individuals. Creditors get more under reorganization than liquidation, but the debtor can avoid selling its non-exempt assets. Municipalities reorganize their debts under Chapter 9, while farmers and fishermen use Chapter 12. Chapter 15 addresses the jurisdictional issues of international entities.
Features
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Businesses typically don't survive Chapter 7 bankruptcy because they are left an empty shell without enough assets to conduct operations. Aside from certain property exemptions, individuals are forced to sell most of their possessions. Obviously they survive, though, and in fact have the chance to rehabilitate their credit rating. If a Chapter 13 or 11 reorganization plan is unworkable, the court-appointed bankruptcy trustee will likely transfer the case to Chapter 7 for liquidation.
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Function
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The purpose of bankruptcy is to give creditors as much as possible from what's available and to divide it among the creditors fairly. Under reorganization this is done through the creation of a repayment plan. The plan lasts for either three or five years and takes into account debts that are collateralized by property (such as car loans or home mortgages) and the differences between the outstanding debt and the current value. When a compromise is reached and the parties agree to the amount of debt to be repaid, the debtor must be able to show enough income to satisfy the debts through regular monthly payments.
Considerations
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When filing for bankruptcy, an individual is permitted to protect certain types of assets, up to a certain value. This is what is called exempt property. Though bankruptcy is a federal process, each state has its own property exemption allowances owing to the differences between them. Some states simply adopt the federal exemptions, while others write their own rules. Others allow the debtor to choose between the state's own rules or federal property exemptions.
History
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The property exemptions are not particularly generous, but they are often enough for small-time debtors to include most or all of their property as exempt, leaving nothing for collection under a liquidation. This loophole was tightened considerably by the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005, which instituted a means test for Chapter 7 bankruptcy. Under the means test, a debtor's disposable income is determined by averaging his monthly income for three months and subtracting certain state-scaled expenses such as clothing, transportation, food and payments on mortgages, cars, child support, alimony or back taxes. If their remaining monthly income is enough to pay off their debts within 60 months, they cannot file for Chapter 7 unless their annual income is below the state median income.
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