Banks must always bear in mind the possibility that in the face of foreclosure their borrower will file bankruptcy. Filing of a bankruptcy petition triggers an automatic stay, halting all collection and enforcement activity against the Bank’s collateral.
Any individual (and most businesses) may file a voluntary bankruptcy petition under Chapter 7 or 11. (Certain regulated businesses, e.g., banks and insurance companies, may not file voluntary petitions.)
Individuals and businesses seeking liquidation generally file under Chapter 7. Under Chapter 7, the debtor’s nonexempt assets are liquidated by a trustee and the proceeds distributed to creditors. Most Chapter 7 consumer cases are “no asset” cases—i.e., no dividend will be paid to unsecured creditors. The primary goal of individuals filing under Chapter 7 is to obtain a discharge of their debts. A discharged debt may not be collected or enforced by the Bank. Discharge may be limited or completely barred under certain circumstances. A debtor who has sufficient monthly income or “means” to make payments to creditors under a Chapter 13 plan is ineligible for Chapter 7. The court may dismiss the Chapter 7 petition or convert the Chapter 7 to Chapter 13. A corporation may not receive a Chapter 7 discharge.
Chapter 9 is intended for use solely by a municipality to adjust its debts.
Chapter 11 is primarily intended for the reorganization of businesses (although individuals not engaged in business are also eligible for Chapter 11 relief). Businesses usually file under Chapter 11 rather than Chapter 7 because the debtor is allowed to remain in possession of its assets, and the same management may continue to operate the business. The equity ownership in the business remains unchanged during the case as well. Generally, a plan of reorganization is proposed, accepted by the creditors and confirmed by the court. Such a plan may alter the rights of secured and unsecured creditors and of corporate shareholders.
Although the ultimate goal is debtor reorganization, the majority of Chapter 11 cases are dismissed or converted to Chapter 7 cases. This may be caused by lack of funds, continuing losses or foreclosure upon all assets after relief from the automatic stay. A Chapter 11 case may also be dismissed if not filed in good faith.
Subchapter V of Chapter 11, the Small Business Debtor Reorganization Act, went into effect February 19, 2020. A small business debtor can file Chapter 11 and elect to be covered by these special provisions. The Bankruptcy Code defines a small business debtor as:
A person engaged in commercial or business activities (including any affiliate of such person that is also a debtor under this title and excluding a person whose primary activity is the business of owning single asset real estate) that has aggregate noncontingent liquidated secured and unsecured debt as of the date of the filing of the petition or the date of the order for relief in an amount not more than $7,500,000* (excluding debts owed to 1 or more affiliates or insiders) not less than 50 percent of which arose from the commercial or business activities of the debtor; and ... [excluding publicly traded corporations]
Chapter 12 is intended for the reorganization of a family farmer with regular annual income. Chapter 12 is modeled after Chapter 13, but permits a family farming operation whose debts exceed the limits permitted under Chapter 13 to reorganize without having to comply with all of the Chapter 11 requirements.
Chapter 13 filings are sometimes referred to as “wage earner” cases. Chapter 13 may be used only by individuals who have no more than a specified amount of unsecured debt and a specified amount of secured debt. (The amounts are adjusted yearly under the Bankruptcy Code.) It is intended as an alternative to liquidation for individual consumers or sole proprietors. [11 U.S.C. §109] A plan must be proposed and confirmed by the court. The plan may require the debtor to repay some or all debts. The debtor is allowed to keep or use all of his property, whether exempt or not. If the plan is completed, the debtor is given a discharge broader than that obtained in a Chapter 7 case. However, the absence of a vote by certain creditors, the ability to rewrite certain secured debts and the less restrictive discharge requirements cause it to be popular with many individuals.
Unsecured creditors may file an involuntary bankruptcy petition against a debtor under Chapter 7 or 11.