Creditor Rights in Bankruptcy

Lesson Transcript
Instructor: Ashley Dugger

Ashley has a JD degree and is an attorney. She has extensive experience as a prosecutor and legal writer, and she has taught and written various law courses.

When bankruptcy is filed by a business or individual, the creditors impacted by the bankruptcy have rights. Understand the definition of bankruptcy, learn the differences between Chapter 7, Chapter 13, and Chapter 11 bankruptcy, and examine the creditor rights under each of these bankruptcy types. Updated: 09/26/2021


I own a small pet grooming business, but it's not doing well. I'm not making much money. I'm behind on both my business and personal bills as a result. I think it may be time to sell or close the business, but I still probably won't have enough money to pay off my debts. I'm headed to see a bankruptcy attorney, so I can explore my options.

Bankruptcy is a method for settling debts that is governed by federal law. It's used by individuals or business entities that are unable to pay debts as they become due. The process is meant to benefit both debtors and creditors. Debtors are able to restructure or relieve debts they can't pay, while creditors are allowed to collect some of what they're owed.

Our federal Bankruptcy Code is found in Title 11 of the United States Code. Because this is federal law, bankruptcy generally works the same from state to state. Occasionally, different states have slightly different laws regarding what types of property can be exempt from bankruptcy proceedings.

There are three main types of bankruptcy proceedings. The types are commonly referred to by their Bankruptcy Code chapter number. I'm not sure which type of bankruptcy I need to file or even if I need to file at all. So let's take a closer look at each type.

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  • 0:07 Bankruptcy
  • 1:30 Chapter 7
  • 3:30 Chapter 13
  • 5:31 Chapter 11
  • 6:56 Lesson Summary
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Chapter 7 Bankruptcy

Let's start by looking at Chapter 7 bankruptcy. This type is a liquidation proceeding used for individuals. It's the most common type of bankruptcy proceeding. I'll consider this type if I decide to file for bankruptcy as an individual rather than as a business. To qualify for a Chapter 7 bankruptcy, I'll have to prove that my income is insufficient to pay my debts.

Let's take a look at how it works. First, the bankruptcy court will appoint a trustee for the debtor's estate. The trustee will then liquidate the estate. A liquidation means that the debtor's non-exempt assets are sold and the proceeds are distributed to the debtor's creditors. Exempt assets are those assets that the debtor gets to keep, even after filing for bankruptcy. These assets aren't part of the bankruptcy estate. Exemptions typically include items like your household goods and your car.

The creditors will be paid in a particular order, or priority, as listed in the Bankruptcy Code. This means that some creditors may be paid in full and some may not be paid at all, depending on the debtor's assets. For example, domestic support obligations and tax bills must be paid before credit card bills are paid.

A debtor can expect to receive a Chapter 7 discharge of debts around four to six months after filing the bankruptcy proceeding. Keep in mind, though, that not all debts are discharged through bankruptcy. Some debts, like child support and student loans, must still be paid.

Also, note that a business can sometimes use Chapter 7, but the discharge of debts only applies to individuals. This means that the business remains liable for old debts. The business must be fully liquidated and cannot later re-open and acquire new assets.

Chapter 13 Bankruptcy

Let's take a look at another option for individual bankruptcy. I might also want to hear about Chapter 13 bankruptcy. This type is less common and is a repayment plan used for individuals with a regular source of income. If you earn more than the median income in your state, you may be declared ineligible for Chapter 7. These debtors may be required to use Chapter 13 instead.

Chapter 13 has strict requirements. If I want to use Chapter 13, I'll have to prove that my unsecured debt, like credit cards and medical bills, is less than $383,175. I'll have to prove that my secured debt, like houses and cars, is less than $1,149,525. Note that these numbers are adjusted every few years for inflation, and these particular figures are current as of 2013.

Chapter 13 proceedings are appealing because the debtor gets to keep all of his or her property. This bankruptcy proceeding requires the debtor to formulate a viable plan for repaying most of the debt. The bankruptcy court must approve the plan.

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