Chapter 7 vs. Chapter 11 Bankruptcy

Learn how bankruptcy rules differ depending on whether an individual or small business files for Chapter 7 or Chapter 11 bankruptcy.

Read below for detailed information about Chapter 7 and Chapter 11 bankruptcy, or jump straight to the chart on Chapter 7 vs Chapter 11 bankruptcy.

Both Chapters 7 and 11 strike a balance between providing debt relief to filers and payment to creditors; however, the type of relief available to individuals and businesses varies significantly—and it isn’t always intuitive. Here are the basics:

  • Chapter 7 can help a business close by selling off its property to pay creditors. Chapter 7 gives both low-income earners and high-income earners exempt from qualification requirements a fresh start by erasing qualifying debt.
  • Chapter 11 can help a business stay open by modifying financial obligations. Chapter 11 can also provide debt relief to high-income earning individuals who don’t qualify for Chapter 13, the reorganization chapter usually filed by individuals.

How Chapter 7 Bankruptcy Works

Only filers who don’t have enough income to pay into a lengthy repayment plan will qualify for Chapter 7. And creditors will receive payment only if the debtor—the person filing the case—owns assets that can be sold by the Chapter 7 trustee—the person responsible for administrating the case. The lack of a repayment plan makes Chapter 7 the fastest bankruptcy chapter to complete.

How long a particular Chapter 7 will take will depend on the property owned by the debtor. For instance, a “no-asset” case—one in which the filer can protect all property using bankruptcy exemptions—is the quickest of all. With no property to sell and, therefore, no creditors to pay, this type of case is over in about three to four months.

By contrast, some filers can protect only some assets, and others aren’t entitled to use exemptions at all. These “asset” cases stay open longer—six months to a year on average—to give the trustee time to liquidate (sell) the property. Cases involving real estate or property ownership litigation often take longer to resolve.

The most attractive benefit of Chapter 7 is that it allows some debtors—but again, not all—the ability to discharge (erase) qualifying debt. The filer will receive the debt discharge after three to four months, even if the case itself remains open while the trustee sells assets for the benefit of creditors.

What Will Happen in Your Chapter 7 Bankruptcy Case

If you’re realizing that one of the complicating factors of Chapter 7 is that it doesn’t treat all filers alike, you’re correct. But the rules aren’t random. The filer’s status as an individual, sole proprietor, or another business entity determines the rules you’ll apply in the following categories:

You’ll find specific examples after “How Chapter 11 Bankruptcy Works.”

When learning about the Chapter 7 process, keep in mind that applying the wrong law could result in significant property loss because a debtor doesn’t have the right to dismiss a Chapter 7 case without court approval. To avoid unexpected results, consult with a bankruptcy lawyer experienced in business-related cases.

How Chapter 11 Bankruptcy Works

Not all struggling businesses are destined to close. When an unexpected event reduces the income stream of an otherwise viable company—as experienced by many at the onset of the coronavirus pandemic—Chapter 11 can help. A filer can restructure debt in any manner that will allow the company to remain open as long as the filer, creditors, and the court agree on the strategy. For instance, a plan of reorganization can include:

  • extending or modifying payment terms
  • lowering interest rates
  • reducing or eliminating debt balances
  • selling assets, and
  • resolving other outstanding issues.

Chapter 11 relief is also available to individual wage earners who don’t qualify for Chapter 7 or Chapter 13. Because such filings are rare, this discussion pertains to businesses only.

The U.S. trustee (or bankruptcy administrator in North Carolina and Alabama) keeps track of the overall case progression through the process by monitoring business operations, overseeing investigations, and ensuring the timely submission of filings, operating reports, and fees. But the U.S. trustee isn’t as directly involved as the trustee would be in Chapter 7 or 13 cases.

It’s the filer or “debtor in possession” who is responsible for carrying out the everyday business operations. But that’s not all. The debtor in possession also fulfills all noninvestigative bankruptcy requirements, such as completing filings and reports, reviewing and objecting to creditor proof of claims, and hiring experts with court approval. The need to be so actively involved is partly why a traditional Chapter 11 is cost-prohibitive for most small companies.

One of the hallmarks of a Chapter 11 case is the extensive creditor negotiations that occur both before and after the case filing, and it’s not unusual for the parties to resolve issues without entering into a formal plan. As with any form of bankruptcy, it’s an abuse of process to use Chapter 11 as a delay tactic with no intention of subjecting to the process.

Filing Status and Chapter 7 and 11 Bankruptcies

Find out what individuals and small businesses can expect when filing under either Chapter 7 or 11 bankruptcy or click one of the links below to go straight to the information you're seeking:

Individuals and Sole Proprietors in Chapter 7

These Chapter 7 filers can keep property using bankruptcy exemptions and can discharge qualifying debt. It’s best suited for a low- or no-income debtor whose property is fully protected by bankruptcy exemptions and whose debts fully qualify for discharge. But as long as the debtor would come out ahead financially—meaning that the amount of erased debt would adequately exceed the value of property lost—Chapter 7 would likely make sense.

Income Qualification Required

These filers must qualify by passing the Chapter 7 means test unless the filer’s business debt exceeds the filer’s consumer debt, thereby exempting the filer from the means test requirement. The exemption creates a “loophole” of sorts that prevents a high-earning filer with substantial business debt from being disqualified automatically.

However, keep in mind that another test exists. The trustee will compare the current income figures listed on Schedule I: Your Income to the expense totals disclosed on Schedule J: Your Expenses. The bankruptcy judge will likely convert the case to Chapter 13 if, after subtracting the two figures, income remains that the filer could use to pay to creditors through a repayment plan. For instance, a filer with a $5,000 monthly income and $3,500 in monthly expenses would have $1,500 available to pay creditors each month. The bankruptcy judge would likely convert the case to Chapter 13.

Property Exemptions Available

Individuals can protect or exempt property using bankruptcy exemptions, such as some equity in a home and car, household furnishings, clothing, a retirement account, and some tools needed in a profession or trade. Many states also have wildcard exemptions a filer can use to protect assets of the filer’s choice.

Sole proprietors can also keep any property covered by bankruptcy exemptions, and if exemptions protect vital business assets—such as needed equipment and product—a sole proprietor might even be able to keep the business open. By contrast, a service-oriented sole proprietorship will almost always survive Chapter 7 because a trustee can’t sell the owner’s future services.

Debt Discharge Available

When an individual files for Chapter 7 bankruptcy, both qualifying personal and business debt get wiped out with the debt discharge—personal guarantees included. The same applies to sole proprietors. Credit card balances, utility and medical bills, lease balances, and personal loans are debts commonly discharged in Chapter 7.

Other Options for Individuals and Sole Proprietors

If a filer would lose important property in Chapter 7, negotiating debt directly with creditors and selling assets might be the better option. Also, Chapter 13 has mechanisms not available in Chapter 7 that will allow filers to do the following:

  • pay off nondischargeable debt (such as recently-incurred tax debt or support obligations) over time without fear of collection actions
  • discharge marital property settlements
  • reduce secured debt on a car, rental property, or other collateral to the property value using a “cramdown” procedure (doesn’t apply to residential real estate), and
  • erase an unsecured junior mortgage on a residential home using a lien stripping mechanism.

Find out when Chapter 13 works better than Chapter 7.

Partnerships, LLCs, and Corporations in Chapter 7

Chapter 7 provides limited benefits to these entities. It works best when the business has substantial assets to sell, and the partners or stakeholders want to relinquish the work of selling it to someone else. Essentially, the filing allows the closing company to hire the Chapter 7 trustee to take the rowing oar in the wind-down process and to assume liquidation and asset distribution-related tasks. Because all property gets sold, filing for Chapter 7 will effectively close the company.

Stakeholders interested in filing for Chapter 7 should keep in mind that the trustee’s interests are aligned more closely with creditors than the debtor, making them natural partners. The more assets the trustee uncovers, the bigger the trustee’s payday, giving the trustee ample incentive to investigate the company’s affairs and potentially mishandled or hidden assets.

Although the transparent nature of bankruptcy can be beneficial, the other option—closing the business outside of bankruptcy—is often more economical and offers less stakeholder scrutiny. Business bankruptcy attorneys decide closure strategy on a case-by-case basis.

Here are some procedural details that apply when these debtors file for Chapter 7.

Income Qualification Not Required

Most filers must take and pass the Chapter 7 means test to qualify for Chapter 7. However, an exception exists when business debt exceeds consumer debt. Because businesses don’t have consumer debt, filing businesses are exempt from the need to qualify for Chapter 7.

Property Exemptions Not Available

When a business files for Chapter 7, the trustee sells all of the business property at fire-sale prices. The trustee then deducts sales costs and an additional percentage as payment for the trustee’s efforts before distributing the remainder to creditors.

This practice can be problematic for stakeholders personally liable for business debt, leaving higher balances than might be possible otherwise. Stakeholders can often limit exposure by negotiating down debt, selling the property for top dollar, and distributing funds outside of bankruptcy. This approach tends to pay more toward creditor payments, leaving less for stakeholders to pay with personal assets.

Debt Discharge Not Available

The partnership, LLC, or corporation won’t receive a debt discharge, and stakeholders remain responsible for any personal guarantees for business debt and other nondischargeable obligations, such as trust fund tax debt.

Other Chapter 7 Considerations

Partnerships rarely file for Chapter 7 because general partners are personally liable for business debt. If a partnership without adequate assets to repay creditors filed for Chapter 7, the trustee could pursue the partners for payment personally and individually—possibly even forcing them into bankruptcy.

Red flags for any business filers include rumblings from disgruntled creditors, business partners, or even ex-spouses. Not only are these individuals the most likely to ask uncomfortable, if not downright dramatic questions at the 341 meeting of creditors—the one hearing all Chapter 7 filers must attend—but things could, and often do, escalate from there. In a nutshell, the trustee gains from the information provided by disgruntled creditors. It can help uncover assets.

Also, a bankruptcy filing increases the chances of a creditor lawsuit. Once a business files a case in bankruptcy court, creditors start looking for ways to get paid. The most basic is by filing a proof of claim. However, if selling the business assets won’t pay much toward claims, creditors might initiate litigation asserting that the stakeholders mishandled assets and attempt to go after their personal assets. Even when meritless, defending a lawsuit is costly.

Chapter 11 Business Bankruptcy Filings

Large businesses with debt exceeding Chapter 11, Subchapter V (Chapter 11, Sub V) small business limits must use the traditional Chapter 11 procedure. Because of the large number of creditors involved and the votes required to approve a plan, Chapter 11 is the most cumbersome and expensive form of bankruptcy, making it unavailable to most small businesses.

It works well if the functioning business has a sufficient income stream to support a reorganization plan (although in some instances, the company can take out a loan for operating capital). Here are some of the procedural requirements that set it apart from Chapter 11, Sub V (discussed further below).

Creditors’ Committee Required

Creditors have significant involvement in a Chapter 11 case. The U.S. trustee appoints a creditors’ committee made up of the seven largest unsecured creditors with the following responsibilities:

  • investigating the debtor in possession’s business operations
  • overseeing case administration
  • participating in plan formation
  • negotiating payment of unsecured creditors’ claims with creditors in other claim categories, and
  • filing lawsuits the debtor in possession refuses to pursue, such as divesting insiders of assets through an avoidance action.

The committee is comprised of unsecured creditors because an unsecured debt—an obligation not backed by collateral—carries with it the least amount of protection in bankruptcy so it’s most at risk of being discharged in a bankruptcy case. By contrast, secured creditors have significant protection—they’re entitled to the property collateralizing the claim if the debt isn’t paid, even in a bankruptcy case.

Disclosure Statement Required

The debtor in possession must fully disclose background information so that a creditor can make an informed decision about the feasibility of the proposed plan. The disclosure statement describes how the plan would pay each class of creditors, along with other information, such as:

  • the business’s present condition and future management
  • the amount creditors would receive in Chapter 7
  • potential preferential claims and avoidable transfers (creditor payments and transactions at risk of being unwound)
  • assets (including valuations)
  • liabilities and tax status
  • potential risks to creditors, and
  • litigation exposure.

Creditors use the company snapshot provided to raise plan objections disguised as disclosure statement objections. Because creditors can also object to the proposed plan, the process gives creditors two “objection” bites at the apple, thereby creating two rounds of litigation.

Once the disclosure statement is approved, the court will set dates for plan objections and creditor voting. The debtor must wait to begin soliciting creditor votes until then unless negotiations predated the bankruptcy filing.

Property Protected

Once the requisite amount of creditor votes is received and the plan is confirmed, the property in the bankruptcy estate vests in the debtor per the plan.

Debt Discharge Available

Once creditor consensus is received and the plan is confirmed, the debtor receives a debt discharge erasing debts identified in the plan. The discharge occurs at the time of confirmation, not after the debtor makes required payments because the confirmed plan becomes a new binding contract between the debtor and creditors.

Chapter 11, Subchapter V Small Business Filings

Chapter 11, Sub V, requires far less creditor involvement in a process that can more closely resemble Chapter 13 than Chapter 11.

Income and Debt Qualification Limits

A business must be functioning and have an income stream sufficient to support a reorganization plan and the company debts must be $2,725,625 or less. However, the CARES Act, in response to the COVID-19 crisis, broadened the small business definition to include a company with debts of $7,500,000 or less. The change remains valid until March 26, 2021.

Heightened Reporting Requirements

Because it can be difficult for a small business to remain profitable and propose a feasible plan, the U.S. trustee provides more oversight throughout the process. For instance, the debtor in possession must submit to an initial interview with the U.S. trustee—something not a part of a traditional Chapter 11—and provide extensive financial information earlier in the process.

No Creditor Committee, Disclosure Statement, or Creditor Consensus Required

Some of the requirements that typically generate litigation in a traditional Chapter 11 aren’t required in Chapter 11, Sub V, such as:

  • the appointment of a creditor committee
  • the filing of a disclosure statement, and
  • plan confirmation by creditor consensus.

As long as the plan pays creditors according to bankruptcy rules and is objectively fair, the bankruptcy judge can confirm (approve) it over creditor objections.

Debt Discharge Available

A debtor must make all plan payments before receiving the debt discharge if the judge confirms the plan without creditor consent.

Chapter 11 Single Asset Real Estate Filings

If a business debtor’s filing involves one piece of commercial real estate or residential property with four or more residential units, it’s considered a single asset real estate filing. Special rules that help protect a secured creditor from loss apply in these cases.

In a single asset real estate filing, a creditor with a secured interest in the property can bring a motion asking the court to lift the automatic stay so that the creditor can move forward with foreclosure or other collection actions. If the debtor in possession can’t file a feasible plan of reorganization or pay interest payments to the creditor, the creditor will win the motion.

Because these cases also often involve cash collateral—a contractual agreement to turn over property rents, accounts receivables, and other cash equivalents to the creditor—these cases often end quickly. Without the use of cash collateral, many single asset real estate debtors can't pay the necessary interest payment.

Similarities Between Chapter 7 and Chapter 11 Bankruptcy

These benefits and procedures apply in both Chapter 7 and 11 cases.

The Automatic Stay

An order called the "automatic stay" immediately stops most creditors from pursuing collection efforts, including wage garnishments, levies, and many lawsuits. Filing for bankruptcy won’t stop all legal actions, however. Criminal cases, some family law matters, and government civil enforcement proceedings will continue. The automatic stay will go into effect if it’s the filer’s first bankruptcy. The rules discourage people from misusing the system by limiting the stay to a month or preventing it from going into effect when someone has filed and dismissed cases recently—usually within the last 180 days.

Who Can File

Anyone can file for Chapter 7 or 11, including individuals, married couples, and business entities. But not every chapter is a good match for every filer—some chapters come with significant pitfalls. Also, filers who have received a debt discharge in the past must wait until the required time elapses before qualifying for a second bankruptcy discharge.

Filing Requirements

Filers must complete a credit counseling course within 180 days before filing and include it with the petition and other official bankruptcy forms. Businesses must be represented by counsel and possess proper filing authority. A filing fee or waiver is also required (more below).

341 Meeting of Creditors

All filers attend at least one hearing called the 341 meeting of creditors. Before the meeting, filers submit verification documentation supporting the financial disclosures in the petition, including tax returns, profit and loss statements, bank statements, and more. At the meeting, the trustee conducting the meeting places filers under oath, verifies identity, and asks standard questions, along with questions raised by the petition. Creditors can appear and ask questions, as well.

Attorneys’ Fees, Filing Fees, Administrative Fees, and Trustee Fees

The costs associated with bankruptcy can add up quickly. Here’s what you can expect to pay.

  • Bankruptcy filing fees. When you file your paperwork, you’ll pay a fee covering some administrative costs. Filers can pay in four installment payments with court approval, and qualifying Chapter 7 filers can request a fee waiver. (Learn the current bankruptcy filing fee.)
  • Required course fees. The pre-filing credit counseling course and the post-filing debtor education course each average $25 to $35.
  • Attorneys’ fees. Bankruptcy lawyers require full payment of Chapter 7 fees before filing. Attorneys’ fees range between $1,200 to $3,500 depending on location with business-related filings costing more. Most attorneys require a hefty retainer in a traditional Chapter 11 case—paying $25,000 and higher to get started wouldn’t be unusual. Filers should pay substantially less for the streamlined Chapter 11, Sub V. (Shop around—an experienced Chapter 13 attorney should be adequately qualified and charge significantly less than a Chapter 11 lawyer.)
  • Trustee fees. The Chapter 7 trustee gets paid a percentage of all sales proceeds dispersed to unsecured creditors (debts not guaranteed by collateral). In Chapter 11, the filer must pay the U.S. trustee quarterly fees of $325 to $30,000, depending on the amount paid to creditors.
  • Administrative fees. Other necessary costs, such as fees associated with hiring professionals like accountants, lawyers, appraisers, and realtors, fall into this category.

Consult With a Business Bankruptcy Lawyer

Whenever a business is involved in a bankruptcy, it’s best to seek professional advice. For instance, many business people find it more beneficial to file an individual bankruptcy after a business closure. An attorney experienced with business bankruptcy cases will evaluate all of the options available and determine how to protect your assets while meeting your goals.

Chart of Differences Between Chapter 7 and 11 Bankruptcy

This table highlights some of the primary differences between Chapter 7, Chapter 11, and Chapter 11, Subchapter V.

Chapter 7

Chapter 11

Chapter 11, Sub V

Type of Bankruptcy

Liquidation

Reorganization

Reorganization

Who Can File?

Individuals, married couples, and business entities

Individuals, married couples, and business entities

Individuals, married couples, and business entities

Debt Restrictions

No debt limitation.

No debt limitation.

Under the CARES Act, total debt cannot exceed $7,500,000 (valid until March 26, 2021, after which it will revert to $2,725,625).

Income Qualification Restrictions

Income must be low enough to pass the Chapter 7 Means Test unless business debt exceeds consumer debt or another exemption applies.

Business or personal income must be sufficient to fund Chapter 11 plan.

Business or personal income must be sufficient to fund Chapter 11 plan.

Other Eligibility Restrictions

Must take credit counseling course during 180 days before filing.

Counsel must represent a business entity and file proof of filing authority.

Must take credit counseling course during 180 days before filing.

Counsel must represent a business entity and file proof of filing authority.

Must take credit counseling course during 180 days before filing.

Counsel must represent a business entity and file proof of filing authority.

Filing Fees

$335 payable in four installments with court permission. Fee waiver available.

$1,717 payable in four installments with court permission.

$1,717 payable in four installments with court permission.

What Happens to Property in Bankruptcy?

Trustee can sell all nonexempt property to pay creditors.

The debtor remains in control of the property, including the business, throughout the case as a "debtor in possession." A trustee isn't appointed.

The debtor remains in control of the property, including the business, throughout the case as a "debtor in possession." A trustee isn't appointed.

What Happens to Debt in Bankruptcy and How Long Does it Take to Receive a Discharge?

Three to four months for individuals and sole proprietors to receive a debt discharge erasing qualifying obligations—other businesses ineligible.

Businesses receive a debt discharge upon plan consensus and confirmation.

Discharge received after completion of plan payments when the bankruptcy judge confirms the plan without creditor consensus.

Benefits

Individuals and sole proprietors can quickly discharge qualifying debt, including personal guarantees and other business-related obligations.

Sole proprietors will include personal and business assets and debts in case.

Businesses can shift the wind-down obligation to sell the business's property to the trustee.

Debtors maintain control over the business and property while restructuring debt, often allowing a struggling business to remain open.

Provides a way to catch up on missed payments to avoid foreclosure or repossession.

Debtors maintain control over the business and property while restructuring debt, often allowing a struggling business to remain open.

Provides a way to catch up on missed payments to avoid foreclosure or repossession.

Doesn’t require a creditors’ committee, disclosure statement, or creditor consensus, making it more cost-effective for small businesses.

Drawbacks

The trustee can sell nonexempt property.

Does not provide a way to catch up on missed payments to avoid foreclosure or repossession.

The personal assets of partnership partners can be at risk.

Filing for bankruptcy opens the door for creditor litigation.

Prohibitively expensive for most small businesses.

Filing for bankruptcy opens the door for creditor litigation, although the risk is lessened by the ability to negotiate with creditors.

Filing for bankruptcy opens the door for creditor litigation, although the risk is lessened by the ability to negotiate with creditors.

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