IF your small business is struggling with debt, you can file for either Chapter 11 bankruptcy or Chapter 13 bankruptcy. Both types of bankruptcy allow you to continue operating your business while you reorganize debts and pay creditors over time. However, while there are some similarities between Chapter 11 bankruptcy and Chapter 13 bankruptcy, but there are major differences as well. It's important to understand the pros and cons of Chapter 11 and Chapter 13 so that you choose the right type of bankruptcy for your small business.
Choosing a Bankruptcy Chapter to Reorganize a Small Business
You must be an individual to be eligible to file for Chapter 13 bankruptcy. Corporations, partnerships and limited liability companies can reorganize under Chapter 11 bankruptcy only. This means that the only type of business that can use Chapter 13 is one run by an individual as a sole proprietorship.
Chapter 13 also has debt limits. If the amount of your secured or unsecured debt (both personal and business) exceeds the Chapter 13 debt limits, you are not eligible and must file a Chapter 11 if you want to reorganize your sole proprietorship. (Find the current Chapter 13 debt limits.)
If your business debts are lower than the Chapter 13 debt limits and you operate your business as a sole proprietor, you have a choice between Chapter 13 and Chapter 11 bankruptcy.
Comparing Chapter 11 and Chapter 13 for an Individual Operating a Small Business
In both Chapter 11 and Chapter 13, you can
- reject (get rid of) unfavorable leases, and
- reduce, or get rid of, liens that exceed the value of property that is pledged to secure repayment of debt. (Learn more about lien stripping and cramdown in Chapter 13.)
But there are significant differences in the way it's done, the time it takes, and the costs. Attorney fees for a Chapter 11 can easily be ten times the amount you would pay for a Chapter 13.
Overall, Chapter 13 is more rigid and moves quickly toward plan approval. You cannot borrow money without court approval at any time during a Chapter 13 bankruptcy, and the situations where you would be allowed to do so are limited.
Chapter 11 moves more slowly and gives you time to do most of your restructuring before you formulate a plan. It is common for the court to approve financing for businesses in Chapter 11 long before a plan is filed.
The Repayment Plan
In both types of bankruptcy, you must file plans setting out how you propose to pay your creditors. Most districts have strict formats that Chapter 13 plans must follow. Chapter 11 plans are more flexible and give you more repayment options. (Learn more about the Chapter 13 repayment plan.)
Time Requirements for Filing Your Plan and Making the First Payment
In Chapter 13 you must file your repayment plan within 15 days of filing for bankruptcy and begin making payments to the Chapter 13 trustee in accordance with your plan within 30 days.
In Chapter 11 there is no time deadline for filing your plan (unless you qualify as a small business where the deadline is 300 days), but if you don’t file it within 120 days of the bankruptcy filing (or 180 days if you qualify under the small business provisions), a creditor can propose a plan for you. Payments under a Chapter 11 plan do not begin until the plan is confirmed (approved) by the court. (Learn more about special provisions for small businesses in Chapter 11.)
Time Allowed to Complete Your Plan
You must complete your Chapter 13 repayment plan within 60 months from the date you file for bankruptcy. You may be eligible for a shorter plan period if your income meets certain requirements but you cannot extend the plan beyond 60 months. If you use the special bankruptcy rules (called cramdown) to rewrite mortgages on investment property, you generally must pay the entire reduced amount during the 60 month period.
In Chapter 11, there is no limit on the duration of your plan, opening up greater possibilities for extended repayment periods.
Sources for Funding Your Plan
Generally, in Chapter 13 you are required to contribute all of your disposable income to the repayment plan for the entire plan period. Disposable income is determined using a formula set out in the bankruptcy laws that includes some actual expenses and other expense amounts that are set by IRS figures. You must have regular income and make periodic (usually monthly) payments to the trustee.
In Chapter 11, the court can deny confirmation of your plan if it does not pay creditors at least an amount equal to your projected disposable income for five years from the date payments under your plan are scheduled to begin, or for the term of your plan, whichever is longer. However, it is different from Chapter 13 because:
- you can use actual expenses to determine your disposable income (so if your actual expenses are high, this could benefit you)
- you are not required to have regular income to contribute to the repayment plan
- monthly payments are not required, and
- you can use alternate sources of funding, such as the proceeds from the sale of real estate or the proceeds from pending lawsuits, in order to fund your plan.
Paying Priority Tax Debt Through Your Plan
In Chapter 13 bankruptcy you can pay priority tax debt over the term of your plan without interest.
In Chapter 11 bankruptcy you can only pay priority taxes without interest if you pay in full at the time that your plan is approved (but since you get more time to file a plan, you may have time to accumulate the cash). You can pay taxes over time in a Chapter 11 but you have to include interest and the time period is limited to five years from the date you file for bankruptcy.
How Your Plan is Approved
In both types of bankruptcy, your plan must be approved by the court at a confirmation hearing before it is effective.
- In Chapter 13, plans are approved if they meet the requirements of the bankruptcy laws. Creditors can object to your plan but they must have a basis for their objection and must present the objection to the court at a hearing.
- In Chapter 11, creditors have the opportunity to vote to accept or reject your plan. They don’t need a reason to vote against your plan and do not need to file formal court papers (other than return their ballot) or appear in court.
Court Monitoring and Discharge of Debt
Individuals, including those that operate businesses as sole proprietors, receive a discharge in Chapter 13 and Chapter 11 only after making all payments due under the approved plan.
In Chapter 13, you make payments under court supervision. You begin to make payments to the Chapter 13 trustee even before the plan is approved, and the case remains open with the trustee collecting payments and making disbursements for the entire life of your plan. The trustee often requires you to submit annual tax returns to show your actual income. In some cases, you might have to modify your plan to increase payments to correspond with increases in your disposable income.
Trustees are not routinely appointed in Chapter 11 cases. Absent fraud or mismanagement, you continue to operate your business while reorganizing. However, until your plan is approved, you must file monthly operating reports to show that
- your business is being run properly
- your are paying taxes and other operating expenses, and
- your business is not continuing to deteriorate.
In Chapter 11, once your plan is confirmed and you begin to pay creditors, the monthly reports are not required and the court may close your case; it will reopen your bankruptcy to enter your discharge when you complete the plan.