Bankruptcy in the United States– How do Bankruptcy Chapters differ?
Bankruptcy is a legal proceeding defined by a country’s laws to deal with the problem where a person or business is not able to repay their debts or obligations according to the contracted terms. In the United States, bankruptcies are governed by federal laws and all bankruptcies are filed in federal versus state courts.
The practice of filing bankruptcy has a long history. As with most US laws, bankruptcy tradition in the United States can be traced back to England. In 1542, during the reign of Henry VIII, England passed the first bankruptcy laws. Before these laws, individuals unable to pay their debts were considered criminals and were subjected to punishment ranging from incarceration to death. Also in the sixteenth century, Spain became the first country to declare bankruptcy.
Current bankruptcy practices in the United States trace back to the The Bankruptcy Act of 1898. (Prior to this act the US passed several laws codifying bankruptcies only to see the laws repealed shortly thereafter.) Congress has passed several acts since The Bankruptcy Act of 1898 that have changed the way in which bankruptcy is treated in the United States. The most important amendments are The Bankruptcy Reform Act of 1978 (“1978 Act”) and the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 (“BAPCPA”).
The 1978 Act provides the basic framework for the US bankruptcy practices outlining the six different bankruptcy methods as separate chapters of the Act. When a certain bankruptcy is referred to as a Chapter 7 or Chapter 11 filing, it means that the rules and guidelines for that bankruptcy are established in that chapter of the 1978 Act. (The 1978 Act has been codified in the U.S. Code in Title 11 of the United States Code, beginning at 11 U.S.C 101.)
BAPCPA amends many of the provisions of the 1978 Act affecting both consumer and business bankruptcies to make it more difficult to file for bankruptcy. In general BAPCPA created more restrictions for bankruptcy debtors. Chapter 7 liquidations were made more difficult. Chapter 11 timelines were tightened. Prior to the BAPCPA Amendments, debtors of all incomes could file for bankruptcy under Chapter 7. BAPCPA restricted the number of debtors that could declare Chapter 7 bankruptcy. The act sets out a method to calculate a debtor's income, and compares this amount to the median income of the debtor's state. If the debtor's income is above the median income amount of the debtor's state, the debtor is subject to a "means test." The new law increased the bureaucratic compliance obligations and shortened the deadline for Chapter 11 reorganizations involving small businesses.
Since the basic premise underlying a bankruptcy is that the debtor cannot meet all the demands of its creditors, determining who gets paid what and in what priority can be very complicated and there are many exceptions. In general, creditors with a secured claim, i.e. a claim that has been registered either according to real estate law or the Uniform Commercial Code are paid first. The bankruptcy code at 11 U.S. Code Section 507 establishes the priority for unsecured creditors. There are some differences in what debts have priority in different bankruptcy chapters.
Our most recent analysis shows that bankruptcies on average take under a year from the inception date to closing; however, there is a wide range of actual outcomes (And the analysis is based on cases that have closed. There are some very long running bankruptcy cases that have not closed and so therefore are not considered. A good example is the bankruptcy for Lehman Brothers which was initiated in 2008 and looks like it will outlast Charles Dickens' fictional case of Jarndyce and Jarndyce.) Also interestingly the average duration of a bankruptcy goes up alongside the bankruptcy chapter.
Current United States bankruptcy laws, rules and regulations provides for the following bankruptcy types:
Chapter 7 Bankruptcy- This the simplest form of bankruptcy. It is available to both individuals and entities. Debtors entering Chapter 7 bankruptcy are simply looking to sell their assets, or liquidate. With some exceptions that would require court approval, funds from the asset sales are distributed to creditors based upon their priority. Typically a trustee is appointed by the court to marshall the debtor’s assets and provide for an orderly liquidation process with the goals of preserving as much value as possible. According to the BankruptcyObserver database Chapter 7 bankruptcies typically take 280 days to be resolved. Debtors in Chapter 7 bankruptcies will be dismissed much earlier than this.
Chapter 9 Bankruptcy- This chapter of the bankruptcy code governs how municipalities such as cities or counties can file bankruptcy. Oftentimes chapter 9 bankruptcies involve small municipalities or municipal organizations. Notable Chapter 9 bankruptcies are Jefferson County, AL in 2011, the City of Detroit in 2013, and the Commonwealth of Puerto Rico in 2017. According to the BankruptcyObserver database Chapter 9 bankruptcies typically take 569 days to be resolved.
Chapter 11 Bankruptcy- Significantly different from chapter 7, Chapter 11 bankruptcies involve the restructuring of the debtor’s obligations with the goal of continuing operations. Chapter 11 bankruptcies typically involve entities like corporations or partnerships; however, some individuals who do not otherwise qualify for bankruptcy may file for Chapter 11. Debtors filing for Chapter 11 must submit a plan for how to restructure their obligations which gets voted on by the creditors within different classes. Debtors have an exclusive right to file a plan for the first 180 days of a bankruptcy which a court may extend to as much as 300 days. Creditors may offer a plan after the exclusive period has expired. According to the BankruptcyObserver database Chapter 7 bankruptcies typically take 550 days to be resolved.
Chapter 12 Bankruptcy- Fashioned in the 1980s to assist family farmers and fishermen, Chapter 12 operates similarly to Chapter 11 but with provisions that work better for these groups. According to the BankruptcyObserver database Chapter 7 bankruptcies typically take 792 days to be resolved.
Chapter 13 Bankruptcy- Chapter 13 bankruptcies represent the highest number of bankruptcies each year. This is the primary manner for individuals to file for bankruptcy. Chapter 13 does not exclusively involve the liquidation of assets. Instead, creditors and debtors work out a plan to repay the debts. The plan doesn’t erase debts, but it allows debtors to pay the debt back over time, typically three to five years. According to the BankruptcyObserver database Chapter 7 bankruptcies typically take 874 days to be resolved.
Chapter 15 Bankruptcy- Added by BAPCPA in 2005, Chapter 15 bankruptcies are to recognize bankruptcy proceedings occurring in foreign countries. It allows individuals and entities to stop creditors from obtaining and liquidating estate assets in the United States until the foreign jurisdiction provides relief. According to the BankruptcyObserver database Chapter 7 bankruptcies typically take 780 days to be resolved.