This article will give a basic outline of the meaning and purpose of bankruptcy and briefly define the three main types: Chapter 11, Chapter 13 and Chapter 7.

To most people the word “bankruptcy” causes feelings of stress, dread and confusion. People don’t know what it means or what is involved in declaring bankruptcy. They don’t know if bankruptcy is right for them, or what to do when someone with whom they have a business arrangement declares bankruptcy. This series of articles is designed to clear up some of the basic questions about bankruptcy. This article will give a basic outline of the meaning and purpose of bankruptcy and briefly define the three main types: Chapter 11, Chapter 13 and Chapter 7. Later articles in the series will go into more detail about each type and how it affects both the bankruptcy debtor and the creditor. Upcoming changes in the bankruptcy laws will also be addressed.

Chapter 11

Chapter 11 is known as the reorganization chapter. Both contractors and owners of businesses will usually file under this chapter although an individual may qualify for Chapter 11 if he or she has significant debts. This chapter is mostly meant for businesses that intend to keep operating, not ones that have lost all hope of continuing. An example of someone who might use Chapter 11 is a contractor who is also the owner of land, is in the middle of a project, and is having a cash flow problem but wishes to finish the project or remain in business.

Once a petition for Chapter 11 bankruptcy is filed with the court, an automatic stay will be issued that will stop all efforts at collection or repossession of the debtor’s property. The purpose of the automatic stay is to allow breathing room from creditors and to allow the debtor to work on a reorganization plan. During this time the debtor will not be responsible for payments due or outstanding obligations. However any subcontractors or suppliers that have contracts with the debtor may, and probably will, still have to fulfill their contractual obligations regardless of the debtor’s ability to pay for those goods or services.

Chapter 13

Chapter 13 is most commonly referred to as the “wage earner plan.” This is because it is mostly designed for wage earners and small business that are not incorporated, such as sole proprietorships and partnerships. Many subcontractors fall into this category of bankruptcy. The main goal of this chapter is to deal with the readjustment of an individual’s debts. The debtor must file a petition with the court for Chapter 13 bankruptcy and attach a budget. The court will assign a trustee to oversee the debtor’s budget. Any amount of disposable income (income beyond that needed to pay for basic necessities) will be turned over to the trustee who will distribute the funds to creditors after taking a trustee’s commission.

When filing for Chapter 13 Bankruptcy, the debtor must meet a “good-faith” requirement. A court-appointed trustee will determine whether or not this requirement is met by reviewing the debtor’s budget to ascertain if the claim was made in good faith. This provision is one that is present to prevent fraudulent claims of insolvency.

Chapter 7

Chapter 7 bankruptcy applies to either individuals or businesses. This step is taken, often, as a last resort. Chapter 7 is used when there is no hope of continuing with the business or getting back on your feet. Under Chapter 7, a business must close its doors and stop production or sales or whatever type of activity with which it is engaged. When a debtor files for Chapter 7, a court-appointed trustee will collect all of the debtor’s assets, liquidate them and distribute them to the debtor’s creditors.

When the debtor files a Chapter 7 petition it must include a list of the debtor’s assets and liabilities as well as a list of the debtor’s creditors and their addresses. Once this petition is filed the same type of automatic stay comes into effect that is present in both Chapter 11 and Chapter 13 bankruptcy.

In the next issue we will go into more detail regarding Chapter 11 bankruptcy issues. We will discuss the requirements for filing as well as what is expected of both the debtor and the creditor when a Chapter 11 petition is filed.