Proceedings brought in the federal courts are governed by Title 11 of the U.S. Bankruptcy Code. The Bankruptcy Code is divided into eight sections: 1, 3, 5, 7, 9, 11, 12, and 13. Chapters 1, 3, and 5 feature general provisions, case administration, and definitions and apply to all proceedings under the Code except those outlined in Chapter 9. Chapters 7, 9, 11, 12, and 13 include material for an eligible debtor (business, government, or individual) seeking protection under the Bankruptcy Code.
Procedural aspects of bankruptcy are covered by the Federal Rules of Bankruptcy Procedure. These rules are promulgated by the Supreme Court and have the force of law. However, the rules may not be inconsistent with the Bankruptcy Code itself.
Each specific chapter contains the rules for conducting bankruptcy. The specific components of each chapter are included in the Bankruptcy Code. Thus, the procedures for Chapter 7 of the Bankruptcy Code are included in Title 11 of the U.S. Code, Chapter 7; the specific rules for Chapter 11 are contained in Title 11 of the U.S. Code, Chapter 11; and so on for Chapters 9, 12 and 13.
Chapter 7 of the Bankruptcy Code provides for an orderly liquidation of all the assets and distributions to creditors. An independent trustee is appointed or elected and is charged with the responsibility to sell or dispose of the assets of the estate, pursue any transfers that are voidable, make distributions to administrative claimholders and creditors, and close the estate. Under Chapter 7, a trustee is always appointed. The debtor discontinues operations and allows the trustee to divide the assets according to each creditor's priority and standing. Chapter 7 is the most common form of bankruptcy.
Chapter 9 bankruptcy is reserved for municipalities. Section 101 of the Bankruptcy Code defines municipality as a political subdivision or public agency or instrumentality of a state. Rarely used, Chapter 9 is available should any municipality choose to avail itself of its provisions.
Entities filing under Chapter 11 of the Bankruptcy Code are seeking to reorganize and continue operations. A reorganization plan must be filed according to specific timetables. If the debtor fails to reorganize within an acceptable period of time, the Chapter 11 can be converted to a Chapter 7 when contemplating liquidation, or the business may be dissolved by developing a Chapter 11 liquidation plan.
Entities that contemplate liquidation from the onset may file under Chapter 11 and develop a Chapter 11 liquidation plan. Such a plan may provide certain benefits to both the debtor and creditors: Debtors may have more control over the liquidation process as a trustee will not automatically be appointed; creditors can form committees and may have a voice in the bankruptcy proceeding. Creditors' committees are rare in Chapter 7 cases. One disadvantage for creditors of a liquidation through Chapter 11 is that even though the debtor may have limited creditor trust due to the problems leading to the bankruptcy filing, the debtor is allowed to liquidate the business. Thus, creditors often demand that an independent party such as an accountant supervise the Chapter 11 liquidation.
No doubt there have been Chapter 11 liquidations that may have cost more than a Chapter 7 liquidation. On the other hand, the cost of new professionals, who duplicate the work previously completed, and trustee fees often make conversion to a Chapter 7 more expensive.
Congress passed Chapter 12, which is reserved for farmers, in 1986 to address the specific needs of "family farmers with regular annual income." Chapter 12 allows farmers with a total debt of $1.5 million or less to reorganize and retain all or part of their farmland. In addition, the individual or the individual and his or her spouse must have earned at least 50 percent of their gross income for the previous taxable year from their farming operations. Farmers who are not eligible for relief, or who elect not to seek relief, or who elect not to seek relief under Chapter 12, may file under another chapter.
Chapter 13 is available to individuals with regular income who wish to adjust their debts as part of a plan approved by the court and creditors. These cases are administered by a standing panel of Chapter 13 trustees. Qualifying small businesses may also file under Chapter 13. Because the debt must be less than $250,000 unsecured and $750,000 secured, Chapter 13 may be used only by individually owned businesses. If the debt exceeds these limits, the individual must file under another chapter.