Chapter 7 Bankruptcy
Under Chapter 7 bankruptcy (also known as liquidation or straight bankruptcy), individuals, corporations and partnerships with severe financial problems are able to wipe out their debts and have a fresh financial start. Chapter 7 is the most common type of bankruptcy, representing more than 70 percent of total petitions filed in 2009. Generally speaking, a Chapter 7 debtor's property is liquidated (sold) and the proceeds are distributed to his or her creditors. At the end of the proceeding the debtor receives a discharge which legally frees the debtor from further responsibility for the debts (though certain debts such as child support cannot be discharged).
Individual Chapter 7 debtors are allowed to keep certain property necessary for everyday living (such as a car or home) provided they keep current with their payments debtors who are behind on payments but want to keep their property should consider Chapter 13 as an alternative. Companies who file for Chapter 7 must cease operations a company that hopes to stay in business should consider reorganizing under Chapter 11.
Bankruptcy attorneys are best qualified to help determine whether Chapter 7 is the best option for you or your business. If your financial situation has contributed to the breakup of your marriage, you will need to speak with a divorce lawyer as well.
Chapter 7 Eligibility
Individuals, married couples (including those seeking a divorce), partnership(s), corporation(s) or other business entities may file for bankruptcy under Chapter 7. The following are the key requirements:
Means Test. Individuals whose household monthly income is below the state average can file under Chapter 7. However, individuals whose household monthly income is above the state average must now satisfy a "means test" to see if they are able to repay some of the debt under Chapter 13 (see sidebar).
Credit Counseling. Individuals who wish to file for bankruptcy must undergo credit counseling from a court approved agency within the previous six months and provide certification to the court. Counseling can be done individually or in a group setting as well as on the phone or even online.
Prior Discharges and Dismissals. You cannot file for bankruptcy if in the past six months you had another petition dismissed because you didn't follow a court order, or if you withdrew your petition after a creditor asked for relief from the automatic stay (a bankruptcy process which temporarily halts all collection efforts such as property foreclosures, wage garnishments, and even harassing creditor phone calls). Additionally, you cannot receive a second discharge under Chapter 7 if you received one in the past eight years (although you may be able to file for bankruptcy in Chapter 13).
Eligibility will vary depending on the debtor's home state. If you are considering bankruptcy, speak to an attorney in your area to learn more. An attorney specializing in family law can help you determine how to proceed with issues that have more to do with family matters, such as a divorce.
How Does Chapter 7 Work?
To initiate a Chapter 7 case, the debtor files a petition together with pertinent financial documents (see sidebar). Immediately upon filing, the automatic stay goes into effect. A court appointed trustee will then determine if the debtor has assets that can be liquidated and distributed to creditors.
The priority for payment of claims to the creditors is fixed by the law as follows:
- Administrative and legal fees are paid first
- Collateral for secured debt is returned to the creditor
- Any remaining proceeds are distributed to the unsecured creditors
Assets. Federal law and state law where the debtor resides dictate exactly which assets are exempt, meaning the individual filing for bankruptcy can keep these assets provided they are not behind on the payments. Exempt assets are generally those necessary for everyday living, as well as pensions, 401Ks, IRAs and the like. If the debtor has any non-exempt assets that are free and clear of liens (or worth more than any security interest or lien and any exemption that the debtor holds in the property), the trustee will liquidate them and distribute the proceeds to the creditors. In reality, most individuals in Chapter 7 do not have non-exempt assets.
Debt. A secured debt is a debt that has collateral attached to it, such as a home or car. The debtor's personal responsibility on a secured debt is forgiven in bankruptcy but they have to return the collateral (property) to the creditor. However, it is important to note the following alternatives:
- The debtor can purchase the asset free and clear after making a lump sum payment to the creditor for the current value of the collateral. The remaining balance of the loan is treated as unsecured debt and discharged in the bankruptcy
- The debtor and creditor can renegotiate the terms of the loan in a "reaffirmation agreement"
- The debtor can surrender the asset to the creditor, leaving the debt unsecured and dischargeable in the bankruptcy
Unsecured debts are debts that are not backed by tangible property, such as credit card debts and medical expenses, as well as the amount that a secured debt exceeds the value of its collateral.
If the court suspects that you have attempted to defraud creditors (e.g., "hiding" assets with friends or relatives) your case may be dismissed. Engaging a bankruptcy attorney to prepare your petition and financial documents will help ensure your legal rights and interests are protected. A family lawyer can advise you on aspects of your situation that pertain to family matters.
Getting a Discharge Under Chapter 7
A Chapter 7 discharge releases individual debtors from personal liability for dischargeable debts, meaning the creditors are legally prohibited from further collection efforts. Examples of dischargeable debts include credit card debt, personal loans, medical bills and tax liabilities that are more than three years old. However, the debtor remains liable for non-dischargeable debts, which may include the following:
- Child support
- Tax liabilities less than 3 years old
- Debts due to a fraudulent act
- Student loans
- Accident liability involving alcohol
- Property liens
- Appliances, jewelry and other large purchases
- Cash advances within 60 days of filing
Importantly, a Chapter 7 discharge only applies to debts listed in the petition. Debts that were accidentally omitted or new debts occurring during the bankruptcy process will not be discharged. It is important to have an attorney help prepare the documents to ensure you get the best outcome.
Chapter 7 debtors tend to have few, if any, assets that may be sold. Therefore, Chapter 7 proceedings are usually faster than other bankruptcy proceedings. To make sure you get the most advantageous treatment of your assets and debts under the Chapter 7 bankruptcy laws, contact a bankruptcy attorney immediately.
Your credit score drops by approximately 250 points and remains on your credit report for 10 years when you file for Chapter 7 bankruptcy, so it is important to speak with a lawyer about whether it is right for you.