Definition
Types of bankruptcies refer to the various categories of legal proceedings for resolving insolvency under bankruptcy laws. The most common types in the U.S. are Chapter 7, a liquidation bankruptcy involving asset selling to repay debt; Chapter 11, a reorganization bankruptcy usually involving businesses restructuring debt plans and operations; and Chapter 13, often for individuals, involving restructuring of debts and a repayment plan over a 3 to 5 year period. These laws offer debtors a financial “fresh start” while also considering creditors’ interests.
Key Takeaways
- The Bankruptcy Code, under U.S law, identifies six distinct types of bankruptcies, each referred to by its chapter within the law: Chapter 7, Chapter 9, Chapter 11, Chapter 12, Chapter 13, and Chapter 15. Each type is designed for specific situations and has different processes and requirements.
- Chapter 7 and Chapter 13 bankruptcies are the most common types for individuals. Chapter 7 involves the liquidation of assets to pay debts, while Chapter 13 allows debtors to keep their property and repay debts over time. Both have their pros and cons.
- Chapter 11 bankruptcy is mainly used by businesses looking to restructure their debts and continue operating. On the other hand, Chapter 9 bankruptcy applies to municipalities and allows cities, towns, and schools to reorganize their debts under federal bankruptcy laws.
Importance
The term “Types of Bankruptcies” is significant in finance as it refers to the various forms of legal declarations that a person or business entity cannot repay outstanding debts to creditors. This will dictate the kind of relief the debtor might receive as well as the potential ramifications for their assets.
The most common types in the U.S. are Chapter 7 and Chapter 13 for individuals, and Chapter 11 for businesses.
Understanding these different types is crucial because each type of bankruptcy carries its own set of rules, procedures, and potential consequences. Additionally, the type of bankruptcy declared will significantly impact a debtor’s credit score, financial future, as well as lenders, and investors who may bear financial losses.
Thus, “Types of Bankruptcies” is not just important to debtors but anyone else in the field of finance.
Explanation
The purpose of bankruptcy is to help individuals or companies resolve their financial difficulties when they can no longer meet their financial obligations. Essentially, it provides a strategy for managing insurmountable debt. Declaring bankruptcy provides an opportunity for individuals or businesses to reduce, reorganize, or even erase their debts.
In the process, it however can greatly damage the debtor’s credit score, which can make it significantly harder for them to secure loans or credits in the future. There are several types of bankruptcies which are organized into “chapters”, each with its own purpose and set of procedures. Chapter 7 bankruptcy, also known as ‘liquidation’, is typically filed by individuals who have little to no possibility of repaying their debts.
It involves selling off the debtor’s non-exempt assets to repay creditors. Chapter 11 bankruptcy, usually filed by businesses, allows for debt reorganization while the business continues operations. Chapter 13 bankruptcy, also known as ‘reorganization’, is filed by individuals with regular income; it entails a plan to repay all or part of their debts over a period of three to five years.
The core intent of the different types of bankruptcies is to give debtors a ‘fresh start’ without being weighed down by crippling debts.
Examples of Types of Bankruptcies
**General Motors (Chapter 11 bankruptcy):** In 2009, General Motors Co., one of the world’s largest automakers, filed for Chapter 11 bankruptcy protection due to exceptionally high debt levels and plummeting car sales. The company’s restructuring plan included debt for equity swaps, layoffs, factory closures, and the elimination of certain brands. The US Government also played a major role in the GM bankruptcy, providing funding and helping guide the company through the restructuring process.
**Lehman Brothers (Chapter 11 bankruptcy):** Lehman Brothers, a large global financial services firm, filed for Chapter 11 bankruptcy protection in 2008 at the height of the financial crisis. Due to its exposure to subprime mortgages and an excessive leverage level, the company was unable to find a buyer or secure government support to avoid bankruptcy. It is still considered the largest bankruptcy filing in U.S. history with over $600 billion in assets.
**Donald Trump’s Hotels and Casinos Resorts (Chapter 11 bankruptcy):** In 2004, Donald Trump filed for Chapter 11 bankruptcy protection for his company, Trump Hotels and Casino Resorts, which controlled several casinos and hotels worldwide. This filing was due to the company’s inability to service its high debt and compete with rivals. After restructuring it emerged from bankruptcy in 2005 and was renamed Trump Entertainment Resorts.
FAQs for Types of Bankruptcies
What is bankruptcy?
Bankruptcy is a legal process that helps individuals or businesses that can’t pay their debts to get a fresh financial start.
What are the different types of bankruptcies?
The common types of bankruptcies in the US are Chapter 7, Chapter 11, and Chapter 13. Chapter 7 is known as straight or liquidation bankruptcy. Chapter 11 is known as reorganization bankruptcy and typically used by businesses. Chapter 13 is designed for individuals who have a regular income and assets that they want to keep, it allows them to propose a plan to repay their debts.
What is Chapter 7 bankruptcy?
Chapter 7 bankruptcy is a process that allows an individual to eliminate the majority of their unsecured debts such as medical and credit card debts. Under this type, the debtor’s non-exempt assets, if any, are liquidated to pay off the creditors.
What is Chapter 11 bankruptcy?
Chapter 11 bankruptcy, often used by businesses, allows the debtor to propose a plan of reorganization to keep its business alive and pay creditors over time. Individuals can also file for Chapter 11, but it is rare due to its complexity.
What is Chapter 13 bankruptcy?
Chapter 13 bankruptcy is designed for wage-earning individuals who want to pay off their debts but need an extended period to do so. It allows them to keep valuable assets, like a home, as they make regular payments to creditors over three to five years.
What is the key difference between Chapter 7 and Chapter 13?
The key difference between Chapter 7 and Chapter 13 is debt repayment. In Chapter 7 bankruptcy, most of the debtor’s debts are discharged without any repayment. On the other hand, Chapter 13 requires a repayment plan to pay off all or part of the debts over time.
Related Entrepreneurship Terms
- Chapter 7 Bankruptcy
- Chapter 11 Bankruptcy
- Chapter 13 Bankruptcy
- Debt Discharge
- Debtor Education
Sources for More Information
- U.S. Courts: The official website of U.S. federal courts, which includes comprehensive information about the different types of bankruptcies.
- Investopedia: A trusted online global resource for independent and unbiased investment education to help investors make more informed financial decisions.
- Nolo: This site provides legal information for businesses and individuals. They have detailed articles on different types of bankruptcy.
- Credit Karma: Credit Karma offers free credit reports and scores, and its blog has useful resources about finance, including the types of bankruptcies.
