There’s no question that deciding whether to declare bankruptcy is very difficult. It affects your future credit, reputation and self-image. However, it could improve your short-term quality of life considerably as debt collection calls and letters stop. Let’s look into Chapter 7 bankruptcy in depth so that you can see what it is and understand how it works.
What is Chapter 7 bankruptcy?
Chapter 7 bankruptcy is a liquidation proceeding in which the debtor’s non-exempt assets, if any, are sold by the Chapter 7 trustee and the proceeds distributed to creditors according to the priorities established in the Code.
Eligibility for file Chapter 7 is determined by the means test instituted with the 2005 amendments to the bankruptcy code.
In most consumer cases, all assets are exempted. Therefore, there are no assets to liquidate and there is no dividend to creditors. Chapter 7 is generally the simplest and quickest form of bankruptcy and is available to individuals, married couples, corporations and partnerships.
Chapter 7 eligibility
In order to be eligible for chapter 7 bankruptcy, the debtor may be an individual, a partnership, or a corporation or other business entity. Subject to the means test described above for individual debtors, relief is available under Chapter 7 irrespective of the amount of debt or whether the debtor is solvent or insolvent. However, an individual can’t file under Chapter 7 or any other chapter, 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 orders of the court, or if the debtor voluntarily dismissed the previous case after creditors sought relief from the bankruptcy court to recover property upon which they hold liens.
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. There are exceptions in emergency situations or where the U.S. trustee (or bankruptcy administrator) has determined that there are insufficient approved agencies to provide the required counseling. If a debt management plan is developed during the required credit counseling, it must be filed with the court.
One of the primary purposes of bankruptcy is to discharge certain debts to give an honest individual debtor a “fresh start.” The debtor has no liability for discharged debts. In a Chapter 7 case, however, a discharge is only available to individual debtors, not to partnerships or corporations. An individual Chapter 7 case usually results in a discharge of debts. However, the right to a discharge is not absolute and some types of debts are not to be discharged. Moreover, a bankruptcy discharge does not extinguish a lien on a property.
How does Chapter 7 work?
A Chapter 7 case starts with the debtor filing a petition with the bankruptcy court serving the area where he lives or where the business debtor is organized or has its principal place of business or principal assets. In addition to the petition, the debtor must also file with the court for the following:
1. schedules of assets and liabilities
2. a schedule of current income and expenditures
3. a statement of financial affairs
4. a schedule of executory contracts and unexpired leases
Debtors must also provide the assigned case trustee a copy of the tax returns or transcripts for the most recent tax year as well as tax returns filed during the case (including tax returns for prior years that had not been filed when the case began). Individual debtors with primarily consumer debts have additional document filing requirements. They must file:
1. a certificate of credit counseling and a copy of any debt repayment plan developed through credit counseling
2. evidence of payment from employers received 60 days before filing if any
3. a statement of monthly net income and any anticipated increase in income or expenses after filing
4. a record of any interest the debtor has in federal or state qualified education or tuition accounts
A husband and wife may file a joint petition or individual petitions. Even if filing jointly, they are subject to all the document filing requirements of individual debtors. (Since they are not available from the court, the Official Forms may be purchased at legal stationery stores or downloaded from the internet.)
The courts must charge a $245 case filing fee, a $75 miscellaneous administrative fee, and a $15 trustee surcharge. Normally, the fees must be paid to the clerk of the court upon filing. With the court’s permission, however, individual debtors may pay in installments. The number of installments is limited to four and the debtor must make the final installment no later than 120 days after filing the petition.
The court may also extend the time of any installment provided that the last installment is paid no later than 180 days after filing the petition. The debtor may also pay the $75 administrative fee and the $15 trustee surcharge in installments. If a joint petition is filed, only one filing fee, one administrative fee and one trustee surcharge are charged. Debtors should be aware that failure to pay these fees may result in dismissal of the case.
If the debtor’s income is less than 150% of the poverty level (as defined in the Bankruptcy Code), and the debtor is unable to pay the Chapter 7 fees even in installments, the court may waive the fee requirement.
To complete the Official Bankruptcy Forms that make up the petition, a statement of financial affairs and schedules, the debtor must provide the following information:
1. a list of all creditors, the amounts and nature of their claims
2. the source, amount and frequency of the debtor’s income
3. a list of all of the debtor’s property
4. a detailed list of the debtor’s monthly living expenses, i.e. food, shelter, clothing, utilities, transportation, taxes, medicine, etc.
Married individuals must gather this information for their spouse regardless of whether they are filing a joint petition, separate individual petitions or even if only one spouse is filing. In a situation where only one spouse files, the income and expenses of the non-filing spouse are required so that the court, trustee and creditors can evaluate the household’s financial position.
Among the schedules that an individual debtor will file is a schedule of “exempt” property. The Bankruptcy Code allows an individual debtor to protect some property from the claims of creditors because it is exempt under federal bankruptcy law or under the laws of the debtor’s home state. Many states have taken advantage of a provision in the Bankruptcy Code that permits each state to adopt its own exemption law in place of the federal exemptions.
In other jurisdictions, the individual debtor has the option of choosing between a federal package of exemptions or the exemptions available under state law. Thus, whether certain property is exempt and may be kept by the debtor is often a question of state law. The debtor should consult a bankruptcy attorney to determine the exemptions available in the state where the debtor lives.
Filing a petition under Chapter 7 “automatically stays” (stops) most collection action against the debtor or the debtor’s property. However, filing the petition does not stay certain types of actions listed under 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.
Between 21 and 40 days, after the petition is filed, the case trustee will hold a meeting of creditors. If the U.S. trustee or bankruptcy administrator schedules the meeting at a place that does not have regular U.S. trustee or bankruptcy administrator staffing, the meeting may be held no more than 60 days after the order for relief. 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. If a husband and wife have filed a joint petition, they must both attend the creditors’ meeting and answer questions. Within 10 days of the creditors’ meeting, the U.S. trustee will report to the US bankruptcy court whether the case should be presumed to be an abuse under the means test described in 11 U.S.C. § 704(b).
The debtor should cooperate with the trustee and provide any financial record or document that the trustee requests. 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, ability to file a petition under a different chapter, 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.
In order to accord the debtor complete relief, the Bankruptcy Code allows the debtor to convert a Chapter 7 case to a case under chapter 11, 12, or 13 as long as the debtor is eligible to be a debtor under the new chapter. However, a condition of the debtor’s voluntary conversion is that the case has not previously been converted to Chapter 7 from another chapter. Thus, the debtor will not be permitted to convert the case repeatedly from one chapter to another.
Role of the trustee
The court exercises its control through a court-appointed person called a “bankruptcy trustee.” The trustee’s primary duty is to see that your creditors are paid as much as possible of what you owe them. The more assets the trustee recovers for creditors, the more the trustee is paid.
The trustee (or the trustee’s staff) will examine your papers to make sure they are complete and look for non-exempt property to sell for the benefit of creditors. The trustee will also look at your financial transactions for the previous year to see if any can be undone to free up assets to distribute to your creditors. In most Chapter 7 bankruptcy cases, the trustee finds nothing of value to sell.
The creditors meeting
A week or two after you file, you (and all the creditors you list in your bankruptcy papers) will receive a notice that a “creditors meeting” has been scheduled. The bankruptcy trustee runs the meeting and, after swearing you in, may ask you questions about your bankruptcy and the papers you filed. In the vast majority of Chapter 7 bankruptcies, this is the debtor’s only visit to the courthouse.
What happens to your property
After the creditors meeting, if the trustee determines that you have some non-exempt property, you may be required to either surrender that property or provide the trustee with its equivalent value in cash. If the property isn’t worth very much or would be cumbersome for the trustee to sell, the trustee may “abandon” the property — which means that you get to keep it, even though it is non-exempt. (For information on which types of property are typically exempt, see When Chapter 7 Bankruptcy Isn’t the Right Choice.) However, which property is exempt varies by state. You can find your state’s exemptions in Bankruptcy Exemptions by State.
Most property owned by Chapter 7 debtors is either exempt or is essentially worthless for purposes of raising money for the creditors. As a result, few debtors end up having to surrender any property, unless it is collateral for a secured debt (see below). To get a better understanding of what may happen to your property in bankruptcy, check out Nolo’s legal area on Bankruptcy Exemptions and Your Property.
How your secured debts are treated
If you’ve pledged property as collateral for a loan, the loan is called a secured debt. The most common examples of collateral are houses and automobiles. If you’re behind on your payments, the creditor can ask to have the automatic stay lifted in order to repossess or foreclose on the property. However, if you are current on your payments, you can keep the property and keep making payments as before — unless you have enough equity in the property to justify its sale by the trustee.
If a creditor has recorded a lien against your property because of a debt you haven’t paid (for example, because the creditor obtained a court judgment against you), that debt is also secured. You may be able to wipe out the lien in Chapter 7 bankruptcy.
Chapter 7 bankruptcy discharge
At the end of the bankruptcy process, all your debts are wiped out (discharged) by the court, except:
1. debts that automatically survive bankruptcy, such as child support, most tax debts and student loans, unless the court rules otherwise
2. debts that the court has declared non-dischargeable because the creditor objected (for example, debts incurred by your fraud or malicious acts).
Chapter 7 bankruptcy pros and cons
Here is a list of pros and cons to consider as you decide whether Chapter 7 bankruptcy is the best option for you.
Chapter 7 bankruptcy pros:
1. Although a bankruptcy stays on your record for years, the time to complete the bankruptcy process under Chapter 7, from filing to relief from debt, takes only about 3-6 months. So, the trade-off is a lasting mark against your credit in exchange for freedom from most debt. If you decide against Chapter 7 when it may be the right decision for you, your missed debt payments, defaults, repossessions and lawsuits will also hurt your credit, and may be more complicated to explain to a future lender than bankruptcy.
2. Most state exemptions allow you enough so that most things you own will be exempt from bankruptcy, sometimes allowing more coverage to keep your property than you need. Additionally, you will get to keep the salary or wages you earn and the property you buy after you file for Chapter 7.
3. Your credit cards probably got you in this mess to start with, so it’s hard to see that as a bad thing. You may also be able to obtain new lines of credit within one to three years of filing bankruptcy, although at a much higher interest rate.
4. There are lenders who specialize in lending to “bad risks,” although that is an unfair characterization to make of someone who has taken a major step to solve financial difficulties.
5. Declaring bankruptcy now can get you started sooner on rebuilding your credit. Although you can only file under Chapter 7 once every six years, you can always get a Chapter 13 plan if there is another disaster before you are entitled to file Chapter 7 again. You may file for a Chapter 13 plan repeatedly, although each filing appears on your credit record.
6. Short of a court order from a family court, nothing else will relieve you of your alimony and child support obligations. However, bankruptcy will alleviate many of your other financial obligations.
7. Nothing will get rid of student loan debt. However, bankruptcy will prevent your lenders from aggressive collection action.
8. Both judges and trustees have heard far worse stories than yours.
9. If, however, you obtained a Chapter 13 discharge in good faith after paying at least 70% of your unsecured debts, the six-year bar does not apply.
10. You can avoid these harsh limitations against refiling for bankruptcy by observing all court orders and court rules and by not asking to have your case dismissed when a creditor asks for relief from the stay. Even if these limitations apply to you, they don’t last forever. You’re only prevented from refiling for a period of six months. It may make sense to at least consult an attorney prior to filing for bankruptcy to avoid limiting your bankruptcy options in the future.
11. If you don’t owe money on the type of debts that survive bankruptcy, the amount and number of debts that a bankruptcy court can relieve you from paying is potentially unlimited.
12. Chapter 7 does not require that you have debts of any particular amount to file for relief. However, even if your case gets converted to Chapter 13, it can still improve your financial situation by obtaining more favorable terms to pay off your debts. With Chapter 13, you get to keep all your property as well.
Chapter 7 bankruptcy cons:
1. Bankruptcy will ruin your credit for some time to come. A Chapter 7 bankruptcy can remain on your credit report for up to 10 years.
2. You will lose property that you own that is not exempt from sale by the bankruptcy trustee. You may lose some of your luxury possessions.
3. You will lose all your credit cards.
4. Bankruptcy will make it nearly impossible to get a mortgage if you don’t already have one.
5. Declaring bankruptcy now might make it harder to do later if something worse comes along. For instance, if you complete the bankruptcy process under Chapter 7, you cannot file for another Chapter 7 bankruptcy for six years. The six years is counted from the date you last filed for bankruptcy.
6. Bankruptcy will not relieve you of your obligations to pay alimony and/or child support.
7. Bankruptcy will not get rid of your student loan debt.
8. You will have to explain to a judge or trustee how you got into the financial mess.
9. You cannot file for Chapter 7 bankruptcy if you previously went through bankruptcy proceedings under Chapter 7 or Chapter 13 within the last six years.
10. You cannot file for Chapter 7 bankruptcy if a previous Chapter 7 or Chapter 13 case was dismissed within the past 180 days because:
11. you violated a court order, or you requested the dismissal after a creditor asked for relief from the automatic stay
12. You may still be obligated to pay some of your debts, such as a mortgage lien even after bankruptcy proceedings are completed.
If you file for Chapter 7 relief but have a certain amount of disposable income, the bankruptcy court could convert your Chapter 7 case to a Chapter 13. This changes your plan to be free from most debts within four to six months to a plan requiring you to repay your debts over the course of three to five years.