Chapter 7 vs. Chapter 11 Bankruptcy: How to Choose
Individuals and businesses alike can file for either Chapter 7 or Chapter 11 bankruptcy. While Chapter 7 is the most common option, some individuals opt for a third type of bankruptcy — Chapter 13 — while businesses typically opt for either Chapter 7 or Chapter 11.
No matter the type, bankruptcy is a legal process that can help you eliminate or reduce some of your debt. Filing for bankruptcy also gives you an automatic stay, or a pause on things like collection calls, debt lawsuits and wage garnishments. Although it comes with heavy consequences, bankruptcy could be the lifeline you need in a financial crisis.
- Chapter 7 is much more common than Chapter 11 bankruptcy for both businesses and individuals. Chapter 11 is more complex and expensive than Chapter 7, though some provisions can make Chapter 11 more affordable for certain small businesses.
- With Chapter 7 bankruptcy, you won’t have a required payment plan. Instead, a trustee may sell your assets that aren’t protected by bankruptcy exemptions. If you are filing a Chapter 7 business bankruptcy, your business will close.
- Chapter 11 is much more likely to be used by businesses than individuals. It may keep your business open, but you must repay at least some of your debt. While you’re making payments, you’ll be under court supervision and must follow financial reporting requirements, such as providing monthly income and cash flow statements.
Chapter 7 bankruptcy at a glance
- Best for: When you aren’t able to repay debt
- Main benefit: Much of your debt may be discharged.
- Main drawback: You could lose assets
- Typical timeline: Typically several months
- Means test requirement: May apply to some individuals with mostly consumer debts
Concerned about affording a bankruptcy filing? Most bankruptcy attorneys offer a free initial consultation. And if you earn a low or moderate income, you might qualify for free- and low-cost legal aid.
How does Chapter 7 bankruptcy work for individuals?
Chapter 7 bankruptcy is also known as liquidation bankruptcy. Under Chapter 7, a trustee will sell nonexempt assets to pay eligible debts. Any leftover eligible debt will be discharged (or forgiven).
You might think that you’ll lose everything if you file for Chapter 7, but that’s not true. Most Chapter 7 bankruptcy cases for individuals are no-asset cases, which means the person filing doesn’t have any eligible assets to sell. The property you’re allowed to keep can vary by state, but generally includes items of daily living, such as basic clothing, necessary household items and cars (or car equity) up to a certain value.
Not everyone qualifies for Chapter 7. If your monthly income, calculated per the terms of the bankruptcy code, is above your state’s median, then you’re required to pass a means test. Basically, this means that you must prove to the court that you truly can’t afford to pay your debt.
How does Chapter 7 work for businesses?
Businesses that file for Chapter 7 bankruptcy will most likely have to shut their doors. A trustee will sell off nonexempt business assets and the proceeds will be applied to the company’s debt.
However, if you’re a business owner who personally files for bankruptcy, there are some exceptions:
- If your business isn’t worth a lot, you might be able to keep it since it won’t bring in much if it were to be sold.
- If you’re a sole proprietor, you may be able to exempt tools of the trade.
- If you’re a sole proprietor and run a service-oriented business (like a hairstylist or personal trainer), your business may be able to continue operating. When you file for bankruptcy, it doesn’t affect revenue you make based on your future labor.
- If you own an LLC or corporation, you’ll have to exempt your shares/ownership interest to keep your business.
Generally, if you want to file bankruptcy and continue running your business, Chapter 11 is the better choice. That said, bankruptcy law is complex and we highly recommend you speak with a bankruptcy attorney.
It’s possible to file for bankruptcy without a lawyer. This is called a pro se filing. But just because something is possible doesn’t mean it’s a good idea. Filing for bankruptcy can be a complicated legal process and, if you represent yourself, you’ll be expected to follow and understand the requirements. Hiring an attorney can help you avoid costly mistakes.
Chapter 11 bankruptcy at a glance
- Best for: Businesses that can repay some of their debt
- Main benefit: Your business could survive.
- Main drawback: The process can be expensive and long.
- Typical timeline: It depends, but can take years.
- Means test requirement: No – Chapter 11 typically doesn’t have Chapter 13-like debt limits, though special eligibility requirements may apply.
How does Chapter 11 bankruptcy work for individuals?
It’s very rare for individuals to file Chapter 11 bankruptcy for themselves. That said, Chapter 11 bankruptcy — or reorganization bankruptcy — is similar to Chapter 13 bankruptcy in that both types involve establishing payment plans with creditors.
Individuals more commonly use Chapter 13 bankruptcy than Chapter 11. Individual Chapter 11 filings may happen if the person has more debt than Chapter 13 allows. To file under Chapter 13, you can’t have more than $526,700 in unsecured debt and $1,580,125 in secured debt.
How does Chapter 11 bankruptcy work for businesses?
Chapter 11 bankruptcy allows business owners to keep their doors open, so long as they agree to follow a court-approved repayment plan.
The repayment plan could be for less than the amount of debt they owe, carry lower interest rates or have other terms that make the debt easier to afford. With court approval, the business may even be able to take out new loans or lines of credit. As the business owner follows court requirements, they’ll be under court supervision via a U.S. trustee.
Chapter 11 is one of the most complicated, lengthy and expensive forms of bankruptcy. There’s no standard start or end date to Chapter 11, but it can take many years to get through.
That said, two provisions can help eligible small businesses afford Chapter 11, and they can also speed up the process: the “small business case” and the “subchapter V case.” In either of these cases, the small business must have no more than $3,424,000 in secured and unsecured debt, at least half of which is the result of commercial or business activities.
Chapter 7 vs. Chapter 11 bankruptcy: side by side
| Chapter 7 | Chapter 11 | |
|---|---|---|
| Who’s it for? | Individuals, married couples and businesses | More commonly businesses, but also individuals and married couples |
| Also known as | Liquidation bankruptcy | Reorganization bankruptcy |
| How does it work? | Sell eligible assets (if there are any) to pay eligible debt, and the remaining eligible debt is discharged | Pay eligible debt under a repayment plan, and you may not need to sell assets |
| How does it affect your business? | Will likely have to sell your business unless you can exempt it, with some exceptions | Business may continue to operate as long as you stick to a court-approved repayment plan |
| Time on credit report | Up to 10 years | Up to 10 years |
| How much are court fees? | $245 case filing fee; $75 miscellaneous administrative fee; $15 trustee surcharge | $1,167 case filing fee; $571 miscellaneous administrative fee; quarterly U.S. trustee fee between $325 and $30,000 |
Common misconceptions around bankruptcy
Myths
- Chapter 7 means you will lose all of your property.
- Chapter 11 is only for billion-dollar companies.
- Your business always closes during bankruptcy.
- Bankruptcy irreparably ruins your credit.
Truths
- Not all assets are sold. The specifics vary by state, but you’ll generally keep items of daily living.
- Small businesses and individuals can pursue Chapter 11 bankruptcy.
- Chapter 11 provides a path for your business to remain open.
- Bankruptcy causes serious damage to your credit, but you can take steps to rebuild even before the bankruptcy falls off your credit report.
Bankruptcy alternatives
There are a ton of pros and cons to bankruptcy — it isn’t going to be the right move for everyone. Before you file, consider the following alternatives.
Debt consolidation
Best if you can afford to pay your debt but qualify for a new lower rate or you are having trouble juggling bills.
Debt consolidation doesn’t change the amount you owe — instead, it restructures your debt. When you consolidate, you’ll take out one debt consolidation loan and use it to pay off your current credit cards and eligible loans. Afterwards, you’ll have just one bill to pay (your debt consolidation loan).
Consolidating can help you save money on interest if you have excellent credit or have improved your credit score. According to a LendingTree study, personal loan rates are typically about 9% lower than the average credit card rate for people with 720-plus credit scores.
It’s also possible to consolidate debt from multiple credit cards onto one balance transfer credit card, potentially with a 0% promotional annual percentage rate. There are specific lenders that offer business debt consolidation loans, too.
Debt management plan
Best if you can’t afford your debt and are ready to overhaul your relationship with money, credit and debt.
If you’re filing for bankruptcy as an individual (not a business), you’re required to go through credit counseling. During the process, your credit counselor might find that you’re a good candidate for a debt management plan instead of bankruptcy.
A debt management plan can help you pay off your unsecured debts in three to five years. Your credit counselor may also negotiate lower interest rates and fees with your current creditors.
However, you’ll have to stop using your credit cards and you can’t open new lines of credit while working the debt management plan.
Frequently asked questions
Yes, an individual can file Chapter 11 bankruptcy. That said, individuals are much more likely to choose between Chapter 7 and Chapter 13 bankruptcy, which are less expensive and typically take less time to complete.
Yes, it’s possible to convert a Chapter 11 bankruptcy case to a Chapter 7 bankruptcy, though there is a specific process to do so. You may decide to pursue this conversion, or creditors might request that the court force one.
For example, a creditor may petition the court to force a conversion if a Chapter 11 business bankruptcy doesn’t come with a reasonable reorganization plan.
Chapter 11 bankruptcy typically costs more than Chapter 7 bankruptcy. That includes court fees: For Chapter 7, it’s a $245 case filing fee, $75 miscellaneous administrative fee and $15 trustee surcharge. For Chapter 11, it’s a $1,167 case filing fee, a $571 miscellaneous administrative fee and a quarterly U.S. trustee fee between $325 and $30,000.
Both Chapter 7 and Chapter 11 bankruptcy can stay on your credit report for up to 10 years. That said, you don’t have to wait 10 years to start improving your credit. You can look into options such as secured credit cards and be sure to keep track of your credit as time passes.
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