2.8 Bankruptcy

Many students think that bankruptcy is a death knell. It is not – necessarily. It can actually be a good thing, which ensures the survival of an enterprise that experienced financial stress. There are different forms of bankruptcy. The forms are categorized by “chapters,” under Title 11 of the United States Bankruptcy Code. Let’s briefly see what the principal bankruptcy forms are, as noted in the Code by chapter, and how each form is different.

Chapter 7:

This bankruptcy form allows debtors to eliminate most or all of their debts over a short period of time, often just a few months. Only student loans, child support payments and some other debts may survive. Here, a trustee is appointed who then liquidates unsecured debts and makes the proper distributions. Collateral on secured debt may be repossessed.  Certain assets will be protected, such as social security insurance. To qualify for Chapter 7, the debtor must satisfy a “means test.” If the test is not satisfied, the debtor may seek relief under Chapter 13.

Chapter 11:

Here, the debtor retains ownership and control of assets. The debtor is referred to as a “debtor in possession.”  The “DIP” runs the day-to-day affairs of the business while the creditors work with the bankruptcy court to work out a plan to be made whole. If the creditors come to an agreement, the business continues operating and certain agreed-upon payments are made. If there is no agreement, the court intercedes; debtors filing a second time are referred to as Chapter 22 filers.

Chapter 13:

In this form, debtors retain ownership and possession of the assets (in contrast to Chapter 7), and will make payments to a trustee from future earnings, which will then be disbursed to creditors. There is a five-year limit in which this process must be completed. Secured creditors may receive larger payments.