Chapter 7 Bankruptcy Basics: Why & When is Property Liquidated?

A bankruptcy liquidation is the process by which a Chapter 7 bankruptcy trustee sells the filer’s assets to repay unsecured debts, such as credit cards, child support, or tax debt, as part of a bankruptcy filing. A popular misconception about Chapter 7 bankruptcy holds that if you file for this kind of debt relief, the United States bankruptcy court will force you to sell all of your property. This is a myth. Chapter 7 bankruptcy is often referred to as “liquidation bankruptcy” because the trustee assigned to a bankruptcy case is empowered to sell an individual debtor’s non-exempt assets. However, a bankruptcy trustee is not empowered to sell all of a filer’s assets. Those that are classified as exempt may not be sold for the benefit of a filer’s creditors. Most of the time, bankruptcy exemptions protect most, if not all, of a filer’s property throughout the Chapter 7 bankruptcy process. Let’s take a closer look at when a Chapter 7 case takes the form of a true “liquidation” bankruptcy.

What Are Assets in a Bankruptcy Estate?

Before you can determine whether your property can be protected under state law or the exemptions in the federal Bankruptcy Code, you need to make a list of your assets. In the context of Chapter 7 bankruptcy, both physical property and intangible property that can be sold for the benefit of your creditors is considered an asset. For example, your couch (physical property) and the balance in your savings accounts (intangible property) could both technically be liquidated by a trustee to partially repay your creditors. Once you file for Chapter 7 bankruptcy, all of the assets you own are then collectively referred to as your bankruptcy estate.

Bankruptcy exemptions allow you to safeguard various kinds of assets from the risk of being sold by the trustee assigned to your case. Depending on where you live and how long you’ve lived there, you will either be required to apply the exemptions allowable by state law or you may be able to apply federal exemptions to your assets. 

A minority of states allow their residents to choose between applying exemptions outlined in state-specific bankruptcy law and federal exemptions. However, a majority of states require filers to apply state-specific exemptions to their assets.

What is a Non-exempt Asset?

Not all assets can be exempted in your bankruptcy filing. You’ll have to follow the bankruptcy law of your state when determining what property you can safeguard and what property must be treated as non-exempt. For example, some states treat all jewelry (save for wedding rings) as non-exempt property. Therefore, if your state doesn’t have a wildcard exemption that allows you to exempt assets of your choice up to a certain value, you may not be able to exempt your jewelry.

Similarly, some assets may be exempted but only to a certain value. For example, you may be able to exempt up to $5,000 of equity in your motor vehicle. Say that your car has been fully paid for and is worth $12,000. Because you can only safeguard $5,000 of that car’s value, you’ll be left with a $7,000 non-exempt asset value to contend with.

If you own non-exempt property or have non-exempt asset values to navigate, you can still file for Chapter 7 bankruptcy, stop garnishments, and benefit from the automatic stay. You’ll just need to take advantage of as many exemptions as you can. With that said, you can also speak with a bankruptcy attorney about whether filing for Chapter 13 bankruptcy and restructuring your debt into a manageable repayment plan may help you keep more of your property, if you’re concerned about losing ownership of specific non-exempt assets and/or asset values.

The Role of the Chapter 7 Bankruptcy Trustee in Liquidating Nonexempt Assets

Before the trustee, who is an independent contractor and overseen by the office of the United States Trustee, determines whether to liquidate your non-exempt assets for the benefit of your unsecured creditors, they will review your schedules and supporting documentation to verify which of your assets are protected by an exemption and which are not. 

When Chapter 7 bankruptcy filers are able to exempt all of their assets, the trustee will inform the court that they don’t expect to distribute any of the filer’s assets. In this scenario, the filer should expect a speedy closure to their case once the discharge order has been entered. 

If a trustee determines that some of a debtor’s assets are non-exempt, they’ll then need to determine whether those assets are worth enough that the trustee should invest time and energy into liquidating them and soliciting such claims. In the event that an asset is at real risk of being sold by the trustee, a debtor can allow the sale to take place, pay the non-exempt value of the asset to retain that asset, or opt to file for Chapter 13 bankruptcy instead to retain ownership over all of their non-exempt assets.

The Discharge of Debts and Chapter 7 Bankruptcy Proceedings

The risk of having any assets sold to partially repay creditors can be enough to scare individuals away from the opportunities that Chapter 7 bankruptcy provides. However, it’s important to remember two key things before dismissing this debt relief option:

1. Most low-income filers eligible to file for Chapter 7 bankruptcy don’t own a lot of assets valuable enough that they can’t be exempted.

2. The benefits that Chapter 7 bankruptcy provides are significant enough that embracing this bankruptcy process is often well-worth the minimal risk that one or more of your non-exempt assets may be sold by the trustee assigned to your case.

The primary benefits associated with Chapter 7 bankruptcy are various bankruptcy protections and discharge of debts. When an individual or spouses filing jointly initiate a bankruptcy proceeding, the safeguards of the automatic stay are put into place, garnishments stop, and creditors are broadly prohibited from collecting on overdue unsecured debts. 

If the court determines that a filer passes the bankruptcy means test for Chapter 7 bankruptcy, that their paperwork is complete, that the filer has attended required educational courses, and has completed their meeting of creditors to a trustee’s satisfaction, the court may then discharge the filer’s eligible debts. 

This discharge of debts is what enables a filer to achieve a financial fresh start. While certain debts, such as overdue child support and certain tax debts, may not be discharged in bankruptcy, others (including credit card debts, medical bills, and other eligible unsecured debt accounts) may be completely eliminated. This process frees a filer from any additional personal liability for the debt incurred. 

Take a minute to imagine what your financial situation would be like if you were freed from all outstanding balances on your credit cards. No more medical bills. No more balances on personal loans. Would this financial freedom finally allow you to start rebuilding your credit score? To attend to your family’s basic needs without worry? To begin building a stable financial foundation? This discharge of debts is what makes the risk of selling some non-exempt assets worth it for many filers.

Note that even if your trustee does opt to sell some of your non-exempt assets the discharge of your debts won’t be slowed down by this decision. Your case will remain open after your discharge order is entered until your trustee has completed their liquidation work.

There can be a silver lining

Sometimes, the liquidation of assets can even be a benefit to certain filers. For example, if you are liable for certain kinds of debts that can’t be discharged, the liquidation of your assets to pay down priority debts may enable you to achieve a sincere fresh start that you couldn’t otherwise benefit from.   

Priority Debts

If your debt load contains overdue alimony or spousal support, overdue child support, and/or tax debt, know that these (and other select debts) are classified as priority debts and can’t be discharged. When a trustee sells a filer’s non-exempt property per the process outlined in U.S. bankruptcy law and overseen by the U.S. Trustee, they will use the proceeds of this sale to pay down a filer’s priority debts first. 

This process allows the filer to reduce their personal liability for these non-dischargeable debts. If non-exempt property wasn’t sold to pay down these debts, the filer would remain totally liable for the outstanding balances until they were paid in full. Sale of non-exempt property allows the balance of priority debts to be reduced or paid in full, depending on the value of assets sold and the total priority debt balance owed.

Conclusion

Most of the time, those who are eligible to file for Chapter 7 bankruptcy don’t end up having any of their assets liquidated by a trustee. However, if you own valuable assets (such as collectibles or real estate) and you’re worried about this risk, know that most bankruptcy law firms offer free consultations. 

By scheduling a free consultation, you can speak to a bankruptcy lawyer about your concerns in a confidential setting, at no cost to you. You may also benefit from attending a free credit counseling session offered by an accredited, non-profit credit counseling agency. This process will allow you to access a personalized debt relief plan and to learn some bankruptcy basics before you speak with a lawyer.

If you choose to file for Chapter 7 bankruptcy and you don’t own significant non-exempt assets, Upsolve’s free app may be able to help you file for bankruptcy on your own without having to hire an attorney.