When people think of bankruptcy, they typically think in terms of "Chapter 7" personal bankruptcy. Under this form of bankruptcy, most of a bankrupt person's debts are cancelled, but the bankrupt person may have to surrender items of property.
Under amendments to bankruptcy law, effective October, 2005, a two-part test is applied to determine if a debtor qualifies for Chapter 7 bankruptcy:
1. Determination of Ability to Repay - The debtor's income is examined under a formula which exempts certain necessary expenses, such as food and rent, to determine if the debtor will be able to repay 25% of his or her "nonpriority unsecured debt".
2. Comparison to State Median Income - The debtor's income is compared to the median state income.
If the debtor earns in excess of the state median income, and is able to repay 25% of his or her "nonpriority unsecured debt", the debtor will be ineligible for Chapter 7 protection and must proceed under Chapter 13.
Debtors must also meet with a credit counselor at some point during the six months prior to applying for bankruptcy, and must attend money management classes at their own expense before a discharge will be issued.
Once a debtor files for bankruptcy, the debtor's estate is protected by the "automatic stay", which bars creditors from trying to collect debts without the permission of the bankruptcy court. This provides immediate protection against foreclosure, repossession of your car, eviction from your apartment, garnishment of your wages or bank accounts, cut off your electricity, or other measures creditors may take to try to recover monies owed. Please note that although the stay may prevent your eviction, any new obligations you incur will be payable to your creditors. That is, if you continue to rent an apartment, although a rent arrearage may be subject to discharge, if you do not pay rent accrued after the date you filed for bankruptcy the court may permit your eviction.
In a Chapter 7 bankruptcy, a trustee is appointed by the bankruptcy court. The primary responsibility of a trustee is to ensure that your creditors are paid as much as possible of what you owe to them. The more of your assets the trustee is able to recover for your creditors, the more the trustee is paid.
The bankruptcy trustee will review the papers that the debtor has filed with the bankruptcy court. The trustee will ask the debtor questions about his assets and obligations at a short hearing, called a"creditors' meeting," which the debtor is required to attend. In most cases, the creditors' meeting is resolved in about five minutes. Although creditors are entitled to attend the meeting, they rarely exercise that option.
The trustee categorizes the debtor's property as "exempt" or "non-exempt", in accord with legal definitions and the dollar limits which apply to various types of exempt property. Once this categorization process is complete, following the creditors' meeting, the trustee will collect the debtor's nonexempt property. The non-exempt property is then sold or liquidated, with the proceeds used to pay off the debtor's unsecured creditors.
A creditor is considered to be a "secured creditor" if the financial obligation to the creditor is protected by a "security interest" in the debtor's property. A "security interest" is sometimes referred to as "collateral" for the loan. For example, a car loan is ordinarily secured by the car, and the existence of the loan is reflected on the car title. The property which secures a loan is exempt from Chapter 7 bankruptcy, although the debtor must continue to make any payments due. If the debtor misses payments, the secured creditor may seek to foreclose upon or repossess the property that secures the debt.
An "unsecured creditor" is a creditor who does not have a security interest in any of the debtor's property. The most common unsecured debt is the outstanding balance owed on a credit card.
Once the trustee has exhausted the funds obtained from liquidating the debtor's non-exempt property, most remaining unsecured debts are discharged.
The Chapter 7 bankruptcy process typically takes four to six months to complete.
Some debts are not ordinarily dischargeable in bankruptcy, or can be discharged only under very extraordinary circumstances. Examples of debts which cannot ordinarily be dischared in bankruptcy include child support obligations, student loans, taxes, and damage awards resulting from intentional wrongful acts or intoxication.
Certain debts incurred within sixty days of a bankruptcy petition, such as debts associated with the purchase of luxury goods or cash advances, will not ordinarily be dischargeable.
In some circumstances, although certain items of property are not exempt, the cost of liquidating the property may exceed its value. As a result, the trustee may allow the debtor to keep certain items of non-exempt property which have little market value, in which case they are deemed "abandoned" back to the debtor, or the trustee may permit the debtor to purchase the items from the estate.
Similarly, where part of an item of property is exempt, but part is non-exempt, the trustee may elect to approach the debtor to purchase the non-exempt portion of the asset. In the alternative, the property may be sold with the value of the exempt portion paid to the debtor.
Some debtors believe that if they attempt to hide their assets, or transfer them to friends or relatives in advance of filing for bankruptcy, they will be able to protect or hide those assets from the bankruptcy process. This is a dangerous assumption, which can subject the debtor to the discharge of a bankruptcy petition and, in some cases, to criminal prosecution
During the course of a bankruptcy, a debtor may ask a court to dismiss the case. If the court finds that dismissal will not harm the creditors, ordinarily a court will grant a petition to dismiss a Chapter 7 bankruptcy.
Once a debtor has examined the various factors affecting whether filing for bankrupcy is appropriate, the debtor will typically choose between a Chapter 7 or a Chapter 13 bankruptcy. A debtor may prefer to file a Chapter 13 bankruptcy petition if:
The debtor wishes to resolve certain debts which may not be discharged in a Chapter 7 bankruptcy;
The debtor wishes to protect certain cosigners on personal loans from being pursued by creditors for repayment;
The debtor wishes to maintain ownership of certain valuable non-exempt property;
The debtor will not be able to keep up with payments on certain items of property, such as a car, while the bankruptcy is pending;
The debtor feels otherwise obligated to repay certain debts (e.g., a moral obligation);
The debtor believes that future creditors will look more favorably on a Chapter 13 reorganization than a Chapter 7 discharge.
A debtor may be required to file a Chapter 13 bankruptcy if:
The debtor has received a Chapter 7 bankruptcy discharge within the prior six years, or obtained a Chapter 13 bankruptcy discharge within the prior six years and and has not paid off at least 70% of the unsecured debts under that bankruptcy.
The debtor was subject to the discharge of a prior Chapter 7 or Chapter 13 bankruptcy filing within the prior 180 days because the debtor violated a court order, or requested dismissal after a creditor sought relief from the automatic stay.
Some debtors discover after filing a Chapter 7 bankruptcy petition that they would be better served by pursuing relief under Chapter 13. For example, certain tax debts which are not dischargeable under Chapter 7 may be included in a Chapter 13 repayment plan. If the debtor has not previously converted a Chapter 7 bankruptcy to a Chapter 13 bankruptcy, and the debtor's estate qualifies for Chapter 13 relief, upon filing an appropriate motion with the bankruptcy court the debtor has an absolute right to conver the petition to a Chapter 13 filing. Where a court approves the motion for conversion, the debtor must file a Chapter 13 repayment plan within fifteen days.
After a debtor files for bankruptcy, until the case is resolved, the debtor's property, assets, and debts will be subject to the control of the bankruptcy court. Subject to a few exceptions, the debtor will be restricted from most financial actions, including the sale of property or the making of payments, without first obtaining permission from the bankruptcy court.
After the completion of a Chapter 7 bankruptcy, a debtor may not again file a Chapter 7 bankruptcy petition for six years from the date of filing.
In a "Chapter 7" bankruptcy:
A trustee is appointed to oversee your property;
Some of your assets will likely be surrendered to the trustee, who will sell them to pay your creditors;
Depending upon the laws of your state, you will be allowed to keep some personal property, and probably an interest in your home (although perhaps not all of your equity).
Most debts are cancelled.
You will most likely be unable to file a "Chapter 7" bankruptcy if you have filed and dismissed a "Chapter 7" petition in the last 180 days, or if you were granted or denied a "Chapter 7" discharge in a prior case within the past six years. If you believe those exclusions apply to you, you should discuss your case with an attorney as you may qualify for an exception.