Chapter 7 bankruptcy is a type of bankruptcy case that can be filed by individuals, married couples, and business entities. It’s the most common type of bankruptcy and provides the fastest form of debt relief. Further, even though it is a “liquidation” bankruptcy that provides for the sale of property to pay creditors, most individual Chapter 7 cases (more than 90%!) don’t require the filer to give up any of their belongings. Continue reading to learn more about how Chapter 7 bankruptcy works and learn more about what everyone filing Chapter 7 bankruptcy should know.
What is the process of a typical Chapter 7 bankruptcy case?
The bankruptcy process every Chapter 7 filer goes through is as follows:
The debtor files the case and the automatic stay goes into effect;
The 341 meeting takes place approximately 20 - 40 days later;
The filer completes the post-filing financial management counseling course;
The court enters a discharge approximately 60 - 90 days after the 341 meeting; and
The case is closed by the court (once the trustee’s work on the case is done).
Why it’s called a liquidation bankruptcy
A Chapter 7 bankruptcy provides the filer with lasting debt relief in the form of a discharge, which can be granted within 3 months of filing their case in the bankruptcy court. In exchange, the filer gives up those possessions that are not protected by an exemption. A trustee takes those so-called non-exempt assets and sells so some of the filer’s debts can be paid with the proceeds. As mentioned, a vast majority of the cases are no-asset cases that don’t result in a payout to creditors.
Example - No Asset Case
Donnie owes $24,000 in credit card debt. He doesn’t have any fancy jewelry, just regular “stuff” like furniture, clothing, and a car he’s still paying on. All of Donnie’s assets are protected by an exemption. The trustee lets Donnie’s creditors know that it’s a ‘no-asset’ case; they will receive nothing from the trustee. Donnie will be relieved from his obligation to pay the $24,000.
If property is available because the filer owns items that the law doesn’t protect, the case is considered an “asset case.” The filer still gets their discharge and the unsecured creditors get a few dollars.
Example - Asset Case
Debbie owes $24,000 in credit card debt. One of Debbie’s possessions is a diamond bracelet that is worth $4,000. The diamond bracelet is not protected by an exemption so the trustee will sell it to pay Debbie’s creditors. Debbie will be relieved from her obligation to pay the $24,000.
Exempt property is property you can keep even after filing Chapter 7 bankruptcy. If all of your property is exempt, you can keep all of it. The law determines which property is exempt and the bankruptcy court decides whether a filer has used the correct law to protect their property. These laws are called exemptions. Each state has its own set of exemptions. Additionally, the federal Bankruptcy Code contains the federal bankruptcy exemptions.
Each state determines whether its residents are able to use the federal bankruptcy exemptions. States that have opted-out of the federal bankruptcy exemptions limit their residents to exemptions set forth in the state law. States that have not opted out give each filer the choice between the state and federal bankruptcy exemptions. You’re never allowed to mix and match between the two.
Non-exempt property and Chapter 13
If someone has a lot of non-exempt property they wish to protect, filing a Chapter 7 bankruptcy is not a good idea. While some trustees give the filer the opportunity to essentially ‘buy back’ their non-exempt assets, they have an obligation to get the highest possible amount of money for creditors. Chapter 13 allows filers to keep their non-exempt property as long as their unsecured creditors are paid enough through the repayment plan to make up for it.
If Debbie, from the example above, wants to keep the bracelet by filing a Chapter 13, she’ll have to propose a repayment plan that pays her unsecured creditors at least $4,000 over the life of the plan. If she can do that, she can keep the bracelet and still get a discharge, but only after completing her Chapter 13 repayment plan.↑ Back to top
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Who are the players in a Chapter 7 bankruptcy?
Each Chapter 7 bankruptcy case has at least 2 active players in the case: The person who filed bankruptcy (the debtor / filer) and the bankruptcy trustee assigned to the case. Depending on the facts, creditors may also play an active role in the case. Let’s take a look at the role each one plays.
This is the person who filed the case to get protection from their creditors and permanent debt relief in the form of a discharge. Before their Chapter 7 bankruptcy petition can be filed, they have to do a couple of things:
(1) Credit counseling
Every consumer filing a bankruptcy petition has to have completed a credit counseling course in the 180 days before their filing date. For a course to satisfy this requirement, it has to be taken from one of the approved providers for the district. A certificate of completion has to be submitted to the bankruptcy court with the petition for relief. After filing, the debtor has to complete a financial management course before their discharge can be entered. This course is again taken from a credit counseling agency that has been approved to offer it by the Office of the United States Trustee.
(2) The means test
Not everyone is eligible for the sweeping relief provided by a Chapter 7 bankruptcy. The purpose of the Chapter 7 means test is to make sure that those who have the means to pay at least some of their debts do so through a Chapter 13 repayment plan. Although many consider a Chapter 7 the “preferred” option, if you fail the means test and don’t qualify, just keep in mind that this means you’re doing better than at least 50% of the people in your state.
The Chapter 7 trustee
The Chapter 7 bankruptcy trustee assigned to the case is in charge of making sure the creditors get what they’re due under the bankruptcy laws. They don’t represent the filer or any specific creditor. But, just like the filer and the creditors, they want to make sure the case proceeds as smoothly as possible. Their duties include reviewing the filer’s tax returns and recent pay stubs and determining whether any property can be sold for the benefit of creditors. To ensure the fair treatment of all unsecured creditors, bankruptcy trustees have wide-ranging powers that include the ability to undo payments to creditors and property transfers where the filer received less than fair market value for the property. In other words, if a filer transfers a piece of property to someone else so it doesn’t come into the bankruptcy estate, the trustee can and will undo that transfer and sell the property.
The trustee’s role in a no-asset case
Once a trustee fulfills their duties and after determining that there are no assets that can be sold for the benefit of creditors, the trustee notifies the bankruptcy court and asks to be relieved from the case. This can happen as soon as the meeting of creditors has been completed. Once a trustee files the no-asset report, the case is essentially on auto-pilot until the discharge is entered. Chapter 7 cases where a report of no distribution (or no asset report) has been filed are closed by the court once the discharge has been entered.
The trustee’s role in an asset case
If assets are available for the trustee to liquidate so creditors can be paid, the trustee will remain involved in the case until that has been done. Oftentimes this extends well past the time that the discharge is entered, as that happens as a matter of course once the filer meets all the requirements. Since trustees often rely on the cooperation of the filer in administering the estate (which is just another way of saying, “handling everything that needs to be handled in the case”), they can ask the bankruptcy court to revoke the filer’s discharge if they don’t cooperate. So, even if you’ve already received your discharge, make sure you keep your trustee and the court up-to-date if your contact information (including your mailing address) changes and be sure to open any and all mail you receive from the court and your case trustee. You jeopardize your discharge if you don’t.
The role of the United States Trustee
The Chapter 7 trustee is an independent contractor for the Department of Justice. The Office of the United States Trustee monitors all case trustees, including all Chapter 7 trustees. This is true in all states except North Carolina and Alabama. There, a bankruptcy administrator fulfills this role. The United States Trustee’s Office gets notice of all bankruptcy filings and conducts random audits to ensure compliance with all applicable laws and procedures.
Creditors are the last set of players in a typical consumer Chapter 7 bankruptcy case. They are further broken down into secured creditors and unsecured creditors. Which category a creditor falls in determines how involved they may be in your case.
Secured creditors have an interest in the property you financed and - if you stop making payments on the debt it secures - have the ability to repossess or foreclose on the property. Even though a bankruptcy filing temporarily stops all collection actions, it does not allow the filer to simply keep the property without paying for it.
Creditors secured by real property
Your mortgage creditor is secured by real estate, specifically, the property you purchased when taking out the mortgage. If you’re not current with your mortgage when your Chapter 7 bankruptcy is filed, the creditor is going to ask the court for permission to move forward with a foreclosure proceeding under applicable state law. This is called a motion for relief from the automatic stay. Once granted, the bank can complete the foreclosure sale, but the filer is not responsible for any deficiency balance. The filer’s personal liability on any balance left owing on the mortgage or any lines of credit secured by the house is eliminated by the discharge.
So, if your goal is to use bankruptcy to catch up on your mortgage after a temporary inability to make payments, Chapter 7 is not the type of bankruptcy you want. Only Chapter 13 bankruptcy gives you the ability to catch up payments to a secured creditor over a period of time.
Creditors secured by personal property
This can take many forms but by far the most common type of creditor secured by personal property are car loan lenders. Like a mortgage company can take your house if you don’t pay your mortgage, your car loan lender can take your car if you don’t make your car payments.
If you’re current with your car loan when your case is filed, you’ll have several options on how to proceed - but more on that later. If you’re not current on your car loan when filing your Chapter 7 case and you can’t catch up by paying all of the past due payments (plus any fees, penalties and interest that may have accrued), you won’t be able to keep the car. While they can’t repossess the vehicle once the automatic stay has gone into effect, they can either (1) file a motion for relief from the automatic stay and get an order granting the motion, or (2) wait until the automatic stay has expired. Once that’s done, they can move forward with a repossession of the car without further notice to the filer.
Unsecured creditors are owed debts that are not connected to a specific piece of property. If an unsecured creditor wants to take something from you - through a wage garnishment for example - they have to file a lawsuit and get a judgment first. Examples of unsecured debts are credit cards, personal loans, student loans, medical bills, etc.
Most Chapter 7 cases do not have any participation by unsecured creditors. If the trustee notifies the court and your creditors that assets are going to be sold and money distributed to creditors, they may file a proof of claim. But, since they’re not allowed to contact you directly once the case has been filed, you’ll likely not hear from them at all.
There is one exception to this general rule: If an unsecured creditor thinks that you shouldn’t be granted a discharge because of certain bad acts, they can object to having the balance owed discharged. More on that here. It doesn’t happen very often, but if it does you’ll want to make sure you speak to a lawyer about how this impacts your fresh start.
Unsecured priority creditors
There is a subcategory of unsecured debts that are given priority status by the Bankruptcy Code. Priority debts generally can’t be discharged and - if the trustee is paying creditors - are given first dibs on any money being paid out. Common examples of priority debts are tax debts and domestic support obligations like child support and alimony. If you have priority debts that can’t be discharged, the money the trustee pays to these creditors will lower your remaining balance owed.↑ Back to top
What kind of debt can be eliminated by filing Chapter 7 bankruptcy?
For most, Chapter 7 bankruptcy eliminates all of their debt. But, there are some categories of debt that can’t be discharged in a Chapter 7 bankruptcy. Let’s take a look at the most common types of non-dischargeable debts.
Domestic Support Obligations: This includes both alimony and child support, which can never be discharged and are generally excepted from the automatic stay. Debts arising from a property settlement agreement from a divorce are dischargeable only in a Chapter 13 proceeding.
Recent Tax Debts: Tax debts incurred in the 3 years before filing are not dischargeable in bankruptcy. A complex multi-step analysis is needed to determine whether any portion of the tax debt owed by the filer can be discharged. Folks with owe older income taxes often benefit from speaking to a bankruptcy attorney about their situation as filing just 1 day too early can make the difference between eliminating a balance owed to the IRS or not.
Student Loans: Student loans can only be discharged in bankruptcy if the filer can show it would be an undue hardship not to. This requires an adversary proceeding.↑ Back to top
What will happen to my car if I file bankruptcy?
Cars are somewhat unique compared to most other personal property as most Americans take out a loan to purchase a vehicle. This loan is a secured debt as described above. But the car itself is also often the most valuable asset a family owns. So, in a way, your car is both an asset and - most often - a liability as well.
Your car as an asset: As long as the value of the vehicle is less than the amount of the available exemption, the trustee can’t reach the car. If you still owe money on your car loan, it’s not the value of the car itself, but rather the equity you have that matters.
Your car as a liability: Chapter 7 bankruptcy does not allow you to keep a car you haven’t paid for. If you’re still paying on your car loan, you have 3 options: If the monthly payments aren’t working and it doesn’t make sense to keep the car, you can give it back and walk away from the loan. If your car is worth significantly less than what you owe on it, you can redeem it by paying the lender the value of the vehicle, not the remaining loan balance. That’s discharged. Finally, you can keep everything the way it was by entering into a reaffirmation agreement. Since that keeps you personally liable on the loan even after your Chapter 7 bankruptcy discharge has been granted, make sure this is what makes sense for you and your family.↑ Back to top
Chapter 7 bankruptcy is a powerful tool for low income families to level the playing field. While there continues to be a stigma associated with the idea of filing bankruptcy, it’s been a lifesaver for many. If you’re struggling with more debt than you can ever hope to repay, whether that’s medical bills, credit cards, or a huge car loan that you can’t afford to pay, Chapter 7 bankruptcy may be the way for you to get the relief you need.↑ Back to top