How does a Chapter 7 Bankruptcy Work?

CHAPTER 7 OVERVIEW

A chapter 7 bankruptcy is a popular type of bankruptcy because it is quick and discharges most debts.  Chapter 7 bankruptcy cases are typically less expensive than a chapter 13. Additionally, a majority of chapter 7 bankruptcies are “no asset” bankruptcies, meaning most of the debtor’s assets are protected by state or federal law and there aren’t any unprotected assets the trustee is interested in taking and selling for creditors.  The entire process for a “no asset” case typically takes around 4 months.  Upon completion, the debtor is afforded a “fresh start” where the debtor is enabled to get rid of unwanted debt such as credit card debt, pay day loans, medical debt, and other unsecured short-term loan debt and even some old individual tax debt.

Most debtors can have their credit score to a good number within about two years after the bankruptcy case is completed.  Surprisingly, it is also not uncommon for debtors to be approved for a mortgage loan about two years after their case has been completed.

ELIGIBILITY

To qualify for chapter 7 bankruptcy, a debtor may be an individual or some kind of business entity.  11 U.S.C. §§ 101(41), 109(b). The amount of the debtor’s debts or whether the debtor is solvent is not a factor in determining eligibility. Qualification primarily depends upon income and whether there was a previous filing.  Normally, the debtors previous six months of income from all sources is evaluated under method called the means test. The average income for this debtor is compared against the average income for families of the same size in the same state.  If the debtor’s average is too high, they will not be permitted to file for chapter 7 bankruptcy and may consider an alternate bankruptcy option such as chapter 13.  For married individuals, the combined household income is considered in this calculation even if only one spouse is filing; nevertheless, where the spouses are separated and not considered in the same household, only the filing spouse’s income is included in the means test calculation. 

If a debtor has filed for chapter 7 bankruptcy within the past eight years and they received a discharge in their previous case, they will not be eligible to file another chapter 7 bankruptcy until the required eight years have passed.

An individual cannot file under chapter 7 or any other chapter, however, if during the preceding 180 days a prior bankruptcy petition was dismissed due to the debtor’s willful failure to appear before the court or comply with orders of the court, or the debtor voluntarily dismissed the previous case after creditors sought relief from the bankruptcy court to recover property upon which they hold liens. 11 U.S.C. §§ 109(g), 362(d) and (e). In addition, no individual may be a debtor under chapter 7 or any chapter of the Bankruptcy Code unless he or she has, within 180 days before filing, received credit counseling from an approved credit counseling agency either in an individual or group briefing. 11 U.S.C. §§ 109, 111.

THE PROCESS

To start a chapter 7 bankruptcy, the debtor takes a class called credit counseling.  Upon completion, the debtor pays the court a filing fee and files a petition with the bankruptcy court in the district in which he or she lives.  The debtor also files schedules of assets and liabilities, schedule of current income, expenditures and a statement of financial affairs and a schedule of executory contracts and unexpired leases.  Fed. R. Bankr. P. 1007(b). The debtor provides the court a copy of the certificate of credit counseling.  11 U.S.C. § 521

A husband and wife are permitted to file a joint petition.

The debtor is assigned to a trustee—an attorney appointed to administer the bankruptcy estate and look after the interests of creditors.  This trustee, in administering the estate, will review the paperwork filed with the court to ensure it is complete and accurate. They will check to see if the debtor has any assets that are not protected by applicable state or federal laws. 

AUTOMATIC STAY

Filing a petition under chapter 7 “automatically stays” (stops) most collection actions against the debtor or the debtor’s property. 11 U.S.C. § 362. But filing the petition does not stay certain types of actions listed under 11 U.S.C. § 362(b), and the stay may be effective only for a short time in some situations. The stay arises by operation of law and requires no judicial action. As long as the stay is in effect, creditors generally may not initiate or continue lawsuits, wage garnishments, or even telephone calls demanding payments. The bankruptcy clerk gives notice of the bankruptcy case to all creditors whose names and addresses are provided by the debtor.

MEETING OF CREDITORS

About a month (between 21 and 40 days Fed. R. Bankr. P. 2003(a)), after the case has been filed, the trustee will conduct a meeting of creditors.  In preparation for this meeting, the trustee will have reviewed the bankruptcy filings, conducted research for any assets owned by the debtor and will review the debtor’s bank and other financial statements covering the month of filing and the most recent tax return.  11 U.S.C. § 521.  During this meeting, the trustee puts the debtor under oath, and both the trustee and creditors may ask questions. The debtor must attend the meeting and answer questions regarding the debtor’s financial affairs and property. 11 U.S.C. § 343. If a husband and wife have filed a joint petition, they both must attend the creditors’ meeting and answer questions. 

The Bankruptcy Code requires the trustee to ask the debtor questions at the meeting of creditors to ensure that the debtor is aware of the potential consequences of seeking a discharge in bankruptcy such as the effect on credit history, the ability to file a petition under a different chapter, the effect of receiving a discharge, and the effect of reaffirming a debt. Some trustees provide written information on these topics at or before the meeting to ensure that the debtor is aware of this information. In order to preserve their independent judgment, bankruptcy judges are prohibited from attending the meeting of creditors. 11 U.S.C. § 341(c).

 If all the debtor’s assets are exempt or subject to valid liens, the trustee will normally file a “no asset” report with the court, and there will be no distribution to unsecured creditors. Most chapter 7 cases involving individual debtors are no asset cases.

ASSET CASE

The primary role of a chapter 7 trustee in an asset case is to liquidate the debtor’s nonexempt assets in a manner that maximizes the return to the debtor’s unsecured creditors. The trustee accomplishes this by selling the debtor’s property if it is free and clear of liens (as long as the property is not exempt) or if it is worth more than any security interest or lien attached to the property and any exemption that the debtor holds in the property. The trustee may also attempt to recover money or property under the trustee’s “avoiding powers.” 11 U.S.C. § 721

Section 726 of the Bankruptcy Code governs the distribution of the property of the estate. Under § 726, there are six classes of claims; and each class must be paid in full before the next lower class is paid anything. The debtor is only paid if all other classes of claims have been paid in full. Accordingly, the debtor is not particularly interested in the trustee’s disposition of the estate assets, except with respect to the payment of those debts which for some reason are not dischargeable in the bankruptcy case.

CHAPTER 7 DISCHARGE

In most cases, unless a party in interest files a complaint objecting to the discharge or a motion to extend the time to object, the bankruptcy court will issue a discharge order relatively early in the case – generally, 60 to 90 days after the date first set for the meeting of creditors. Fed. R. Bankr. P. 4004(c).

A discharge releases individual debtors from personal liability for most debts and prevents the creditors owed those debts from taking any collection actions against the debtor. A creditor may no longer initiate or continue any legal or other action against the debtor to collect a discharged debt

Secured creditors may retain some rights to seize property securing an underlying debt even after a discharge is granted. Depending on individual circumstances, if a debtor wishes to keep certain secured property (such as an automobile), he or she may decide to “reaffirm” the debt. A reaffirmation is an agreement between the debtor and the creditor that the debtor will remain liable and will pay all or a portion of the money owed, even though the debt would otherwise be discharged in the bankruptcy. In return, the creditor promises that it will not repossess or take back the automobile or other property so long as the debtor continues to pay the debt. If the debtor decides to reaffirm a debt, he or she must do so before the discharge is entered. The debtor must sign a written reaffirmation agreement and file it with the court. 11 U.S.C. § 524(c)

Certain debts are not discharged or wiped out in a chapter 7 bankruptcy.  These include student loans or loans made or guaranteed by a governmental unit, child support, employee withholdings or 941 taxes, alimony, criminal fines, debts arising from a drunk driving charge, debts for willful and malicious injury by the debtor to another entity or to the property of another entity , traffic tickets and debts incurred fraudulently. 11 U.S.C. § 523(a) Recent income taxes (within the last three years) cannot be discharged and that taxes owed prior to three years ago may be discharged but are subject to sometimes-complex analysis regarding whether the tax will be discharged. The debtor will continue to be liable for these types of debts to the extent that they are not paid in the chapter 7 case.  Debts ordered by debt pursuant to a divorce decree your former spouse can be objected to and not discharged. 11 U.S.C. § 523(c); Fed. R. Bankr. P. 4007(c)

REVOCATION

The court may revoke a chapter 7 discharge on the request of the trustee, a creditor, or the U.S. trustee if the discharge was obtained through fraud by the debtor, if the debtor acquired property that is property of the estate and knowingly and fraudulently failed to report the acquisition of such property or to surrender the property to the trustee, or if the debtor (without a satisfactory explanation) makes a material misstatement or fails to provide documents or other information in connection with an audit of the debtor’s case. 11 U.S.C. § 727(d).

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