Bankruptcy
Why it Matters
When a person or a business cannot pay its debts, the law does not leave creditors to fight over whatever remains. Federal bankruptcy law provides one uniform system that gives honest debtors a second chance while treating creditors fairly and in a fixed order. Some debtors need a clean break, and others need time and protection to reorganize. Choosing the wrong chapter can cost a debtor a home or a business. In this activity you analyze three fact patterns with an AI: which chapter fits each debtor, what it means for the creditors, and what the debtor could have done differently.
Current Context
On July 28, 2026, the federal judiciary reported that bankruptcy filings rose 12.2 percent (opens in a new tab) in the year ending June 30, to 608,511 cases, most of them under Chapter 7. Business filings rose 16.9 percent, and total filings have climbed every quarter since a low in June 2022, though they remain far below the 2010 peak of nearly 1.6 million. On August 3, 2026, the Senate unanimously passed (opens in a new tab) the Bankruptcy Threshold Adjustment Act, and on September 16 the House passed its own version (opens in a new tab) and sent it to the Senate. Both would permanently restore debt limits that fell back when a temporary increase expired in 2024: $7.5 million for Subchapter V small business cases and $2.75 million for Chapter 13. Those limits decide who may use the faster, cheaper Subchapter V track through Chapter 11 and who may file under Chapter 13 at all, the chapters in Fact Patterns 2 and 3.
PetPals Unleashed
PetPals Unleashed is a story told one chapter per activity, and each chapter turns on that activity’s law. Read it as the outline of a page you will write: in the Project, you turn all twelve chapters into a book.
Chapter 7
The workout agreement expires and the bank moves to collect. With seventy-two hours before the bank seizes PetPals’ assets, Noodle files a voluntary Chapter 11 bankruptcy petition. The automatic stay stops the bank cold. What follows is a painful but survivable reorganization: restructured debt, shed contracts, and a company that emerges leaner and still intact. PetPals made sure it never needed Chapter 11 again. The reorganization also cleared the path for what would eventually become the most complicated legal event in the company’s history.
Key Concepts
Bankruptcy
A federal process under Title 11 of the United States Code that lets individuals and businesses that cannot pay their debts seek relief in a federal court. Because the law is federal, a single case can halt collection and bind creditors wherever they are. The Code is the same in every state, but it borrows state law at key points, including the exemptions that decide what property an individual debtor keeps.
Automatic Stay
The injunction that takes effect the moment a petition is filed, without any court order, and halts nearly all collection activity: lawsuits, garnishments, foreclosures, repossessions, and creditor calls. It gives the debtor room to assess the situation and, in a reorganization, time to propose a plan before creditors dismantle the business.
Bankruptcy Estate
The pool of property created at filing, consisting of all the debtor’s legal and equitable interests at that moment. An individual debtor may claim some of it as exempt, and in Chapter 7 a trustee sells the rest to pay creditors. In Chapters 11 and 13 the debtor usually keeps the property and pays creditors from future income or restructured operations under a plan.
Secured and Unsecured Creditors
Secured creditors hold a lien on specific property, such as a mortgage on a home or a perfected security interest in equipment, and have first claim on its value. Unsecured creditors share what remains, and certain unsecured claims, such as domestic support and administrative expenses, have priority and are paid ahead of the rest. An interest that was never perfected under Article 9 may be treated as unsecured, which is why the filing rules from the last activity matter so much here.
Discharge and the Fresh Start
A discharge is the court order that wipes out the debtor’s personal liability for covered debts, so creditors can never collect them from the debtor. It carries out the fresh start policy: an honest debtor who has exhausted the ability to pay should be able to keep enough to live on and reenter economic life. Student loans, certain taxes, domestic support, and debts a court finds came from fraud generally survive, and so does a lien on the debtor’s property.
Chapter 7 Liquidation
The most common chapter, open to individuals and businesses: a trustee takes control of the estate, sells the nonexempt assets, and distributes the proceeds in order of priority. An individual usually receives a discharge within a few months, though a consumer debtor with income above the state median must first pass a means test. A business that files Chapter 7 gets no discharge; it closes and is liquidated.
Chapter 11 Reorganization
The reorganization chapter used mainly by businesses: the debtor usually stays in possession of its assets and proposes a plan restructuring its debts, subject to a creditor vote and court confirmation. With the court’s approval, the debtor may assume or reject its executory (unfulfilled) contracts and unexpired leases; rejection generally leaves the other party an unsecured claim for damages. Chapter 11 is complex and expensive, but it can save a business that is worth more alive than sold for parts, as PetPals learns in Chapter 7 of the story.
Chapter 13 Individual Reorganization
A repayment plan for individuals with regular income and debts below the statutory limits, funded from future earnings over three to five years. It lets a debtor keep nonexempt property that Chapter 7 would liquidate. It can also save a home in foreclosure, because the plan can cure the arrears over time while the debtor keeps up the regular payments.
Resources
- Textbook: Chapter 30, Bankruptcy (opens in a new tab) (The assigned reading on the bankruptcy system and its chapters. Its dollar figures, such as the Chapter 13 debt limits and the means test amounts, are out of date, and it predates Subchapter V, the small business track added to Chapter 11 in 2019.)
- Basics of Bankruptcy Law, LawShelf (opens in a new tab) (A free video course in five modules, with one each on Chapters 7, 11, and 13.)
- The Difference Between Chapter 7 and Chapter 13 (opens in a new tab) (An Arizona bankruptcy attorney’s 13-minute comparison of the two consumer chapters used in Fact Patterns 1 and 3, from how long each takes to the means test.)
- Chapter 11: Bankruptcy restructuring, Khan Academy (opens in a new tab) (A 14-minute explanation of how a business reorganization works, the path in Fact Pattern 2.)
- Bankruptcy Basics, United States Courts (opens in a new tab) (The federal judiciary’s plain-language guide to the process, and the guide the Foundation Builder asks you to check the AI’s overview against.)
- Chapter 7 Bankruptcy Basics, United States Courts (opens in a new tab) (Eligibility, the means test, the trustee’s role, and discharge.)
- Chapter 11 Bankruptcy Basics, United States Courts (opens in a new tab) (The debtor in possession, the plan, and confirmation, including the small business and Subchapter V tracks.)
- Chapter 13 Bankruptcy Basics, United States Courts (opens in a new tab) (Eligibility, debt limits, and the repayment plan.)
- 11 U.S.C. § 362, Automatic stay, Cornell LII (opens in a new tab) (The statute that stops the garnishment in Fact Pattern 1 and the foreclosure in Fact Pattern 3.)
- 11 U.S.C. § 523, Exceptions to discharge, Cornell LII (opens in a new tab) (The debts that survive bankruptcy.)
- 11 U.S.C. § 541, Property of the estate, Cornell LII (opens in a new tab) (What goes into the bankruptcy estate.)
- 11 U.S.C. § 727, Discharge, Cornell LII (opens in a new tab) (Who receives a Chapter 7 discharge and who does not.)
- Florida Statutes Chapter 222, Method of Setting Apart Homestead and Exemptions (opens in a new tab) (Florida’s exemption statutes. Section 222.20 bars Florida residents from the federal list, and section 222.25 protects up to $5,000 of a debtor’s interest in one vehicle.)
- U.S. Bankruptcy Court, Middle District of Florida (opens in a new tab) (The court where a Volusia County debtor files.)
- Means Testing, U.S. Trustee Program (opens in a new tab) (The means test data, including each state’s median income, chosen by the date a case is filed; the Florida median is where the analysis starts for Marcus in Fact Pattern 1.)
- Automatic stay, Cornell Wex (opens in a new tab) (A plain-language explanation of the stay and its exceptions.)
- Discharge, Cornell Wex (opens in a new tab) (A short general definition of a discharge; the Chapter 7 guide above covers what a bankruptcy discharge leaves in place.)
What to Do
This activity uses three fact patterns, one for each of the three main bankruptcy chapters, to show you what sets each chapter apart. As you work through them, watch for what makes each situation different. Why is Chapter 7 the answer in one and Chapter 11 in another, and why is Chapter 13 available in the third? You post reflections on your analysis of each.
Part 1: The Socratic Analysis Sequence
Work through all four prompts for each fact pattern before moving to the next. Start with the Foundation Builder to establish your baseline understanding of the Bankruptcy Code. Next, present the first fact pattern to the AI and use the Issue Spotter to identify which chapter applies and why. Then use the Analyst to predict the outcome for the debtor and the creditors. Finally, use the Strategist to evaluate the financial decisions that led to the bankruptcy in the first place. Repeat the sequence for each of the three fact patterns.
Fact Pattern 1 (Chapter 7): Marcus is a 34-year-old freelance graphic designer with $87,000 in unsecured credit card debt and $12,000 in medical bills accumulated after a period of illness that ended his primary client relationship. He has no significant assets: he rents his apartment, owns a six-year-old car worth approximately $4,000, and has $300 in his checking account. His current income from irregular freelance work is well below the Florida median income. He has not paid his credit cards in eight months. Two creditors have filed lawsuits seeking judgments. A third has begun garnishment proceedings against his bank account.
Fact Pattern 2 (Chapter 11): Hartwell Bakery Inc. is a regional bakery with fourteen employees, two retail locations, and a wholesale distribution operation supplying twenty-three restaurants. A combination of rising ingredient costs, a failed third-location expansion, and a costly equipment failure has left the company $1.2 million in debt: $400,000 secured by equipment and inventory, $800,000 in unsecured trade credit and supplier obligations. The business is still generating revenue and the core operations are profitable, but the debt load is unmanageable under current terms. The primary secured lender has issued a notice of default and indicated it intends to exercise its remedies within thirty days. The owner believes the business can survive if given time to restructure.
Fact Pattern 3 (Chapter 13): Diana is a registered nurse earning $74,000 per year. She owns a home with $40,000 in equity and has fallen $18,000 behind on her mortgage after a divorce and a period of reduced hours. Her mortgage lender has initiated foreclosure proceedings. She also has $22,000 in credit card debt and a $9,000 car loan she has kept current. Her total secured and unsecured debt is within the statutory limits for Chapter 13. She has stable employment and consistent monthly income but cannot pay the mortgage arrears in a lump sum.
Part 2: Draft Your Reflections
After you finish all four prompts for a fact pattern, write a reflection of at least 100 words. Address how well you identified the applicable chapter, how accurately you analyzed the likely outcome, and what you learned about how bankruptcy law balances competing interests. Write one reflection per fact pattern. In addition, write a single introductory reflection of at least 100 words covering your experience with the activity as a whole.
Part 3: Post Your Deliverables
Post all of your work as a single new thread. Your post must include your introductory reflection followed by your three individual fact pattern reflections.
Part 4: Share Chat Link
Include one AI chat link with a 1–2 sentence explanation of what the conversation shows and why you chose to share it.
Suggested AI Prompts
Use these prompts as a starting point, then adjust them to fit your goal. Strong prompting develops through trial, revision, and testing. It’s a foundational skill that grows into more advanced AI work such as context engineering and agent-based workflows.
Foundation Builder
Act as a bankruptcy law professor. Create a clear and thorough overview of U.S. bankruptcy law written in plain language for college students who are new to the topic. Organize the overview into logical categories covering the purpose and policy foundations of federal bankruptcy law, the function and scope of the automatic stay, the concept of discharge and the fresh start principle, the distinction between secured and unsecured creditors, and the three primary chapters available to individuals and businesses: Chapter 7 liquidation, Chapter 11 reorganization, and Chapter 13 individual reorganization. Under each category, explain the most important concepts and rules. For each chapter, explain who it is designed for, what it accomplishes, and how it differs from the others. Cite the section of Title 11 for each major rule, and tell me plainly when you are not sure of a citation so I can check it on Cornell’s U.S. Code site or against the federal courts’ Bankruptcy Basics. Write in clear paragraph form throughout.
A map of the Code with citations you can check. Its categories track the concepts above, and the section numbers, with the doubtful ones flagged, let you test the framework against the statute and the courts’ own guide before you rely on it.
Issue Spotter
Act as a Socratic law tutor. I will share a bankruptcy fact pattern. After I share it, invite me to read through it carefully and identify the most important bankruptcy law issues, starting with which chapter of the Bankruptcy Code applies and why, which creditors are secured versus unsecured, how the automatic stay would affect the situation, and what outcome the debtor is likely to achieve. I will write a short summary identifying and briefly explaining each issue I spot. Once I provide my summary, give me feedback on what I identified correctly, what I missed or mischaracterized, and how I can sharpen my ability to spot and frame bankruptcy issues with greater precision.
A checklist you fill in first. The prompt names four questions that open a bankruptcy analysis, then waits for your answers, so the feedback targets your reasoning instead of handing you the result.
Analyst
Act as a federal bankruptcy judge. I will share a bankruptcy fact pattern. After I share it, invite me to write a paragraph explaining how I think the issues should be resolved: which chapter applies, what happens to the debtor’s assets or income, how the automatic stay affects pending creditor actions, what the likely outcome is for the debtor and the major creditor classes, and whether the debtor is likely to receive a discharge. Once I share my analysis, provide detailed feedback on what I did well, where my reasoning was imprecise or incomplete, and how I can improve my analysis to reach clearer and more accurate conclusions.
A judge’s review of your prediction. Bankruptcy judges decide exactly these questions, and the persona keeps the feedback focused on whether your outcome follows from the Code rather than on whether it sounds reasonable.
Strategist
Act as a financial strategist and attorney. I will share a bankruptcy fact pattern describing a debtor in financial distress. After I share it, invite me to write a paragraph that does two things: first, explain how the bankruptcy process resolves the situation under the applicable chapter, and second, identify the specific financial and legal decisions the debtor made, or failed to make, that led to bankruptcy in the first place and what they could have done differently to avoid it entirely. After I share my response, give me feedback that connects bankruptcy doctrine to the practical financial and legal decisions that businesses and individuals make long before they ever set foot in a bankruptcy court.
Looking upstream from the filing. Every bankruptcy has a history of earlier choices, and asking you to trace them turns the doctrine into advice a business owner could use before things go wrong.