Chapter 11 vs. Chapter 13 Bankruptcy: What’s the Difference?

Chapter 11 vs. Chapter 13 Bankruptcy: An Overview

There are some notable differences between Chapter 11 and Chapter 13 bankruptcy, including eligibility, cost, and the amount of time required to complete the process. Both bankruptcies give debtors the opportunity to stay in business and restructure their finances.

Barring some limitations, both bankruptcies allow filers to modify their payment terms on secured debts, provide time to sell assets, and eliminate obligations the filer cannot pay over the plan’s term. While both allow the discharging of debts, more debts can be discharged under Chapter 13.

Chapter 11

Nearly everyone can file for Chapter 11 bankruptcy, including individuals, businesses, partnerships, joint ventures, and limited liability companies (LLCs). There is no specified debt-level limit and no required income. However, Chapter 11 is the most complex form of bankruptcy and generally the most expensive. That's why it’s most often used by businesses rather than individuals.

Filing Chapter 11 bankruptcy allows businesses to stay open and continue operating while reworking their financial obligations. Filers are able to put forth a reorganization plan, which can include downsizing and plans to reduce their expenses.

Many large businesses have filed for Chapter 11 bankruptcy and come out of it later to continue operating. For instance, General Motors and Chrysler both went down this path in 2009. With the advent of the COVID-19 pandemic, a veritable avalanche of bankruptcies is occurring, including such high-profile companies as J. Crew and J.C. Penney.

Chapter 13

Chapter 13 bankruptcy can only be filed by individuals with a stable income. Debt limitations are also part of Chapter 13 eligibility, and the limits change every three years. The limits will change on April 1, 2022, to $465,275 in unsecured debt and about $1.4 million in secured debt, with those limits valid until April 2022. Chapter 13 differs from Chapter 7, through which individuals can use Chapter 7 to wipe out all their debt entirely. Chapter 7 does have income limits that vary by state. 

For Chapter 13 individuals must submit and implement a repayment plan for debts to be paid within three to five years. The filer can generally keep some assets, such as a home and an automobile. It’s also called a wage earner’s plan, where individuals pay a monthly amount to a trustee, who in turn pays the individual’s creditors. The payback to creditors is usually required to be equivalent to or better than what they’d receive under other bankruptcy proceedings.

Why File for Chapter 11?

The main reason to file for Chapter 11 bankruptcy is to be able to prevent a business from permanently closing. Of course, the company must be in a position where the restructuring of its debt makes financial sense. By staying in business while reorganizing debt, the company has a fighting chance at solvency. The downsides are its expense and complexity. Smaller businesses often lacked the resources to use it.

That’s why the Small Business Reorganization Act of 2019, which went into effect on Feb. 19, 2020, added a new Subchapter 5 to Chapter 11 designed to make bankruptcy easier for small businesses. The act defines them “as entities with less than about $2.7 million in debts that also meet other criteria,” according to the U.S. Department of Justice, and it “imposes shorter deadlines for completing the bankruptcy process, allows for greater flexibility in negotiating restructuring plans with creditors, and provides for a private trustee who will work with the small business debtor and its creditors to facilitate the development of a consensual plan of reorganization.” 

Reasons to File for Chapter 13

The main reason for an individual to file for Chapter 13 bankruptcy is to prevent the liquidation of all their assets. It is frequently used to avoid the forced sale of an individual’s home, which Chapter 7 can’t do. Chapter 11 may also prevent a forced home sale, but is usually too expensive and complicated a procedure for most people. Of course, not everyone has the choice to use Chapter 13. Having a stable income is a crucial qualifier, and there is that debt limit of $2.75 million as well.

Chapter 11 vs. Chapter 13

Chapter 13 involves the appointment of a trustee; with Chapter 11 this is optional and not usually done. The trustee’s role includes reviewing the bankruptcy proposal, and making recommendations to the court, along with collecting and distributing creditor payments.

If a debtor meets all the requirements, there’s no limit to a Chapter 11 plan’s duration, though typical plans are structured for three to five years. The court can extend the time frame of the plan for debtors who need more time to make the required payments.

The approval process for a Chapter 13 bankruptcy is generally much more expedient. There’s a set commitment period, however, of three to five years, during which a debtor must relinquish essentially all disposable income to the appointed trustee for distribution among creditors. The commitment period can be shortened but never extended (except in the following special circumstance).

Changes Due to the COVID-19 Pandemic

The Coronavirus Aid, Relief, and Economic Security (CARES) Act, signed into law by the president on March 27, 2020, made a number of changes to bankruptcy laws designed to make the process more available to businesses and individuals economically disadvantaged by the pandemic. These include raising the Chapter 11 Subchapter 5 debt limit to $7,500,000, excluding federal emergency relief payments due to COVID-19 from “current monthly income” in Chapter 7 and Chapter 13 and “disposable income” in Chapter 13, and allowing Chapter 13 repayment plans to be extended to seven years. The changes apply to bankruptcies filed after the CARES Act was enacted and sunset one year later.

The Bottom Line

Filing for bankruptcy is one option that an individual or business has when it can no longer repay its financial obligations. It starts off with a petition and ends up with a discharge. There are several different types of bankruptcies, including Chapter 11 and Chapter 13. While Chapter 11 filings can be filed by nearly anyone, Chapter 13 filings are reserved for those with a steady stream of income and who meet debt limit thresholds. These filings allow individuals to pay down their debts over time using a proposed payment plan. As with any financial undertaking, it's always a good idea to consult a professional for advice on what option may be best for you.