When facing financial difficulties, it’s essential to know your options. Although bankruptcy may appear daunting, it can be a strategic solution for recovery. In this guide, we’ll explore the differences between Chapter 11 and Chapter 13 bankruptcies to help you determine the best path forward. We’ll also introduce an alternative solution that many overlook when under financial stress.
What is Chapter 11 Bankruptcy?
Chapter 11 bankruptcy is often associated with large corporations, but it’s available to businesses of all sizes and, under certain circumstances, to individuals as well. This form of bankruptcy allows a business to continue operating while reorganizing its debts. This is essential for individuals who want to avoid liquidation and keep their businesses open and operating.
In Chapter 11, the debtor remains in control of business operations as a “debtor in possession” and works to restructure debts under the oversight of the court. The process includes creating a detailed plan of reorganization, which creditors and the court must approve. The plan outlines how debts will be managed and paid, potentially including downsizing or renegotiating debt terms with creditors.
Who Uses Chapter 11?
Typically, Chapter 11 is used by companies whose debt or organizational structure is too complex for Chapter 13 but needs the reorganization aspect that Chapter 7** does not offer. Individuals whose debts exceed the thresholds for Chapter 13 also may opt for Chapter 11.
**As a reminder, Chapter 7 bankruptcies don’t involve repayment plans like Chapter 11 and Chapter 13 plans offer. With a Chapter 7, non-exempt assets are sold off to pay off creditors and remaining debts are wiped out.
What is Chapter 13 Bankruptcy?
Chapter 13 bankruptcy, also known as a wage earner’s plan, caters to individuals with a regular income who can pay back at least part of their debts through a structured repayment plan. It’s designed to help individuals—sole proprietors included—avoid the outright liquidation of their assets and settle their debts over an agreed-upon timeframe.
Under Chapter 13, the debtor proposes a repayment plan to make installments to creditors over three to five years. A trustee is appointed to oversee the case, including collecting payments from the debtor and disbursing them to creditors. A Chapter 13 plan needs to offer terms at least as favorable as the terms creditors would get in a Chapter 7 bankruptcy.
Who Uses Chapter 13?
This chapter is best suited for individuals who have fallen behind on payments but have a steady income to complete a repayment plan. It’s particularly useful for those seeking to prevent home foreclosure or car repossession.
Key Differences Between Chapter 11 and Chapter 13 Bankruptcy
Understanding the key distinctions between Chapter 11 and Chapter 13 bankruptcy can help you navigate the complex terrain of financial restructuring. Here, we set out the nuances of eligibility, costs, and outcomes associated with these two common forms of bankruptcy.
Eligibility Requirements
Chapter 11: Broad Access for High-Debt Entities
Chapter 11 bankruptcy is designed to accommodate a wide range of filers, from large corporations to individuals whose financial obligations exceed typical thresholds. This chapter does not impose defined debt limits, making it a viable option for high-debt individuals and various types of businesses, including partnerships and limited liability companies (LLCs).
It caters especially to those entities with complex financial situations that cannot be addressed through other bankruptcy forms. This flexibility makes it a critical tool for reorganizing substantial unsecured debt and secured debt alike, providing a lifeline to entities facing overwhelming financial burdens. Firms in Chapter 11 must, however, be viable entities worth saving and capable of generating positive cash both during and after bankruptcy.
Chapter 13: Structured for Individuals with Regular Income
In contrast to Chapter 11, Chapter 13 bankruptcy is specifically targeted at individuals—including sole proprietors—who have a regular income and whose debt does not exceed certain limits. These limits are periodically adjusted to reflect current economic conditions and are set to ensure that filers have enough disposable income to handle a repayment plan.
Chapter 13 guidelines formerly had separate debt limits for unsecured and secured debts, but those distinctions were eliminated by a change in the law in 2022. As of the date of this blog, there is a single limit of $2,750,000, and it can include both secured and unsecured debts. Once again, this type of bankruptcy is particularly well-suited for those with a consistent monthly income and a desire to manage their debt load without relinquishing personal assets.
Cost Implications
Chapter 11: High Costs for Complex Cases
The financial commitment involved in filing for Chapter 11 bankruptcy can be substantial. Due to its complexity, this form of bankruptcy typically requires detailed legal strategies and extensive documentation, driving up the need for comprehensive legal support and advisory services.
The filing fees alone, which include a large administrative fee and additional charges for the procedural handling of the bankruptcy case, are significantly higher than those for Chapter 13. For instance, the fee to file a Chapter 11 case can exceed $1,700, not including attorney fees and other related costs, which can accumulate depending on the duration and complexity of the case. Depending on the complexity of the bankruptcy, the attorney’s fees and other costs can run into the tens of thousands.
Chapter 13: More Affordable for Individuals
On the other hand, Chapter 13 bankruptcy is generally less costly. It involves lower filing fees which are often in the $300 range and include a modest administrative fee. The process also requires less legal maneuvering, which can significantly reduce attorney fees. The overall administrative and legal expenses are designed to be manageable for individuals, reflecting the personal nature of this bankruptcy type and its focus on facilitating debt repayment rather than restructuring large or corporate debts. With attorney’s fees though, a Chapter 13 filing can still cost several thousand dollars.
Duration and Outcome
Chapter 11: Variable Timeframe with Tailored Outcomes
The duration of a Chapter 11 bankruptcy case can vary widely. Some cases may conclude within a few years, while more intricate cases involving larger businesses or more complicated debt structures can extend much longer. The debtor in a Chapter 11 case must propose a reorganization plan, that both creditors and the court must approve – a process that can extend the timeline significantly. The outcome is tailored to the business’s needs, allowing for operational adjustments and debt restructuring that can ensure long-term viability.
Chapter 13: Fixed Repayment Period with Comprehensive Debt Relief
In contrast, Chapter 13 bankruptcy features a more standardized timeframe, limiting the repayment plan to three to five years. This structure is intended to provide a clear path to debt relief for individuals.
The debtor proposes a plan to use their disposable income to pay off debts, which must be more favorable to creditors than if the debtor’s assets were liquidated under Chapter 7 bankruptcy. Upon successful completion of the repayment plan, the debtor often benefits from a more comprehensive discharge of remaining debts, including some types of unsecured debts like credit card debts and medical bills, which can provide significant financial relief and a fresh start.
Impact on Credit
All bankruptcy filings can severely impact a borrower’s credit. Chapter 7 filings, however, have the worst impact, as the bankruptcy itself will stay on a debtor’s credit for up to ten years and all of the charge-offs associated with the debt liquidations will remain on the debtor’s credit report for several years as well – and bring down his or her credit score substantially.
Creditors look much more favorably on a Chapter 13 bankruptcy though because it indicates that a debtor is willing to pay down his debts via a plan as opposed to just wiping them out. A Chapter 13 filing will still lower a debtor’s credit score and remain on his credit for up to seven years.
Chapter 11 filings can sometimes have a minimal impact on a debtor’s credit if they only involve his business. However, if there are personal debts involved or other aspects of the filing relating to the debtor’s personal estate, a Chapter 11 filing can adversely impact your credit.
Alternative to Bankruptcy
Because bankruptcy can be very expensive and because it can severely harm a debtor’s credit, there is an alternative that every borrower should be aware of: a cash-out mortgage refinance. Many debtors fail to consider this option because they believe their credit is too poor to qualify or that their income is too low to qualify.
However, there are mortgage loans available for borrowers with relatively low credit scores. There are also mortgage loans that allow borrowers to “pay off debt to qualify” for the mortgage. That means that lenders will consider a borrower’s debt ratios as if the cash-out mortgage was fully funded and all of a borrower’s debts had been consolidated into the mortgage. These debt consolidation mortgages can save borrowers thousands of dollars every month—and, more importantly, enable borrowers to avoid bankruptcy altogether.
FHA mortgages for example will allow for credit scores as low as 580 and even lower in some cases. FHA will also allow for “cash out” mortgages up to 80% of the value of a property, as long as the borrower resides in the property. In addition to FHA, there are other mortgage types that allow borrowers to use alternative income documentation for incomes, such as bank statement deposits.
IMPORTANT NOTE: If you have substantial equity in your home (20% or more), you may be able to avoid bankruptcy altogether by refinancing your mortgage with cash out.
If you’d like to explore this option, please reach out to Hannah Papazian at JVM Lending at hpapazian@jvmlending.com or call (855) 855-4491.
Summary
Both bankruptcy chapters offer pathways to debt relief, but the right choice depends heavily on the debtor’s specific circumstances, including their debt types, total debt levels, financial status, and long-term goals. Whether restructuring through Chapter 11 or consolidating debts in Chapter 13, it’s important to consider all variables and consult with bankruptcy experts to navigate these complex legal waters effectively.
Frequently Asked Questions
What’s the difference between Chapter 7 and Chapter 13 bankruptcy?
Chapter 7 bankruptcy involves liquidating the debtor’s assets to repay creditors or just discharging debts in general if there are insufficient assets to cover the debts. In contrast, Chapter 13 allows debtors to keep their assets and repay creditors over a three to five-year period, based on their income and debt load.
What type of bankruptcy has the worst impact on someone’s credit?
Chapter 7 bankruptcy has the worst impact, followed by Chapter 13 bankruptcy. Chapter 11 bankruptcy can sometimes have minimal impact.
Can businesses file for Chapter 13 bankruptcy?
No, Chapter 13 is designed only for individual debtors, including sole proprietors. Businesses that operate as corporations or partnerships cannot file under Chapter 13 and might consider Chapter 11 instead.
How are secured and unsecured debts treated in these bankruptcies?
In both Chapter 11 and Chapter 13, secured debts (like mortgages and car loans) must be paid as per the loan terms or renegotiated, while unsecured debts (like credit cards and medical bills) can often be reduced or restructured based on the debtor’s ability to pay.
What is the alternative to bankruptcy?
One alternative involves a cash-out refinancing of a mortgage – if borrowers have sufficient income, credit, and equity in their homes. As discussed above though, there are loan programs that are very flexible nowadays when it comes to income and credit.
Choosing Between Chapter 11 and Chapter 13
Deciding between Chapter 11 and Chapter 13 bankruptcy involves evaluating your financial situation, types of debt, and long-term financial goals. Each chapter offers different protections and outcomes, making it vital to understand the implications of each option fully.
At JVM Lending, we understand the complexities involved in choosing the right bankruptcy chapter, and we’re happy to refer you to a competent bankruptcy attorney if you believe filing for bankruptcy protection is your only option.
If, however, you would like to consider a cash-out mortgage in an effort to avoid bankruptcy, this is where we are true experts. If you have questions about pursuing a cash-out mortgage as an alternative to filing bankruptcy, contact Hannah Papazian at JVM Lending by phone at(855) 855-4491 or email hello@jvmlending.com.
