The Two Different Bankruptcy Paths: Liquidation and Rehabilitation, Part I

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This post is the first of a two-part article.

The Bankruptcy Code consists of several different chapters. Several chapters-Chapter 7, Chapter 11, the new “Subchapter V” for small businesses in Chapter 11, Chapter 12 for farmers, and Chapter 13- set out different ways that debtors can get out of debt. They all boil down to two fundamentally different philosophies: liquidation and rehabilitation.

Liquidation roughly translates into up front payment. Cough up what you have to creditors, except for property deemed exempt by the Bankruptcy Code. Exempt property may include homestead and some personal property. After the debtor pays up with nonexempt property, it’s over. The debtor can just walk away from old debt. So the debtor gets the benefit of a relatively simple and quick bankruptcy, compared to rehabilitation. At the end of liquidation, the debtor enjoys a “fresh start.” But not before. If the debtor gets new property (like an inheritance) within 180 of filing the petition, the debtor’s property may get forked over to creditors. Still, Chapter 7 may be one of the cheapest ways for qualified individuals to go through bankruptcy. The only liquidation method in the federal bankruptcy code is through Chapter 7. Not everyone qualifies for Chapter 7.

While liquidation wipes out the debts of the past, rehabilitation empowers debtors to pay off debt in the future, through a multiyear plan. With rehabilitation, the debtor presents a plan to creditors, with the goal of getting creditors back their money over a period of time.

The most popular rehabilitation chapter, Chapter 13, allows debtors to structure a plan to pay off debt up to a five year period. During this period of time, the debtor remains in bankruptcy. The Chapter 13 debtor will typically not be able to recover from the credit rating hit until after the debtor completes the multiyear bankruptcy plan.

For some debtors, liquidation under Chapter 7 may be more appealing. Liquidation tends to be cheaper, faster, and better at rebuilding credit. But Chapter 13 has several important advantages. I will cover a few of them next week in Part II of this article.

My practice, J Haskins Law, is a debt relief agency. J Haskins Law helps people file for bankruptcy relief under the Bankruptcy Code.

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