When people think of bankruptcy, they usually think of a Chapter 7 liquidation proceeding, a bankruptcy process that concludes with the discharge of most or all of their debts. 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 that will be sold so that the proceeds may be applied to their debts.
If a person filing for Chapter 7 bankruptcy has no assets in excess of their exemptions, the amounts and values of property they are legally allowed to exclude from the bankruptcy estate, then their bankruptcy is deemed a no-asset bankruptcy.
In order to qualify to file for Chapter 7 bankruptcy, a debtor's income and assets are reviewed under two-part means test that is designed to determine if they can reasonably repay a portion of their debt:
Comparison to State Median Income - The debtor's income is compared to the median state income for a family of equivalent size to the debtor's. If the debtor's income is less than the median state income, the debtor may file a Chapter 7 bankruptcy petition. If not,
Determination of Ability to Repay - The debtor's income is examined under a formula that 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. Debtors who are able to repay 25% of their nonpriority unsecured debt are ineligible for Chapter 7 protection and if they want to file a bankruptcy case must proceed instead under Chapter 13.
In a Chapter 7 bankruptcy, a trustee is appointed by the bankruptcy court to represent the creditors. 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 that the trustee is able to recover for your creditors, the more the trustee is paid.
The bankruptcy trustee will review the documents that the debtor has filed with the bankruptcy court, including the schedules that describe the debtor's assets, debts and creditors. The debtor is required to attend a short hearing called creditors meeting or, more technically, a 341 hearing, at which the trustee will ask the debtor questions about his assets and obligations at. In most cases, the creditor's meeting is completed 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 nonexempt, in accord with legal definitions and the dollar limits that apply to various types of exempt property under the exemptions available to the debtor under state or federal law. Once that categorization process is complete and the creditors meeting has been held, the trustee will collect the debtor's nonexempt property. The nonexempt property is subsequently sold or liquidated, with the proceeds used to pay off the debtor's unsecured creditors, those whose claims are not secured by collateral.
When a debtor has a secured loan, the debtor has the option of surrendering the collateral as part of the bankruptcy process, or reaffirming the debt. A reaffirmation agreement with a creditor must be approved by the bankruptcy court, and must be found by the court to be in the best interest of the debtor. If a debt is reaffirmed, the debt will not be affected by the discharge in bankruptcy, and will be owed in full once the bankruptcy process is complete. Once reaffirmed, if a debtor misses a payment the lender may seek to recover the collateral through processes such as repossession or foreclosure. As many lenders will not proceed with repossession or foreclosure as long as they continue to receive payments, some debtors do not formally reaffirm their secured debts but continue to make payments until they either pay off the loan or are in a position to refinance.
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. A creditor may be partially unsecured, meaning that although the creditor has a claim to collateral the value of the collateral is not sufficient to cover the debtor's full debt balance. When a creditor is undersecured, amount in excess of the value of the collateral may be treated as unsecured debt.
Once the trustee has exhausted the funds obtained from liquidating the debtor's non-exempt property, most remaining unsecured debts are discharged. Many unsecured creditors receive only pennies on the dollar or, in some cases, nothing.
The Chapter 7 bankruptcy process typically takes four to six months to complete.
Once a debtor files for bankruptcy, the debtor's estate is immediately protected from creditors by the automatic stay. The stay bars creditors from trying to collect debts incurred prior to bankruptcy without the permission of the bankruptcy court. The stay gives debtors immediate protection against foreclosure, repossession of a car, eviction from a home or apartment, garnishment of wages or bank accounts, having their utilities cut off, or other measures creditors might take to try to recover monies owed.
Although the automatic stay may prevent eviction over past rent due, any new obligations incurred by the debtor remain payable to your creditors. That is, if the debtor continues to rent an apartment, although a rent arrearage may be subject to discharge, if the debtor dos not pay rent accrued after the date the bankruptcy petition is filed the court may permit eviction.
Some debts are given special protections from discharge in bankruptcy, and are called "priority debts". Priority debts include child support, spousal support, fines from criminal cases, taxes, and federally guaranteed student loans, and the amounts owed are not normally dischargeable in bankruptcy.
All other debts, such as a car loan or credit card bill, are nonpriority debts. A secured debt is associated with collateral that may be claimed by the creditor in the event of a default, such as the home for a home mortgage, or a car for a car loan. Unsecured debts have no collateral. The second branch of the means test considers only nonpriority unsecured debt, such as credit card bills, medical bills, and personal loans.
If a bankrupt person is able to repay a portion of their nonpriority debt, they may be required to do so out of the assets of their estate. For example, if a person is found to have sufficient assets to pay 20% of their nonpriority debt, such as a medical debt, the 20% payment would be made during the course of the bankruptcy, with the remaining 80% of the debt discharged.
During the six months prior to applying for bankruptcy, at the debtor's own expense, a debtor must meet with a qualified credit counselor. A debtor must also attend money management classes at their own expense before an order of discharge will be issued by the bankruptcy court.
In addition to priority debts, some debts may not be discharged in bankruptcy. Common debts that cannot be discharged include court fines, criminal restitution 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. The purpose of this exclusion is to discourage debtors from running up additional debt immediately before filing a bankruptcy petition.
Although an item of property may not be exempt and thus may be subject to being liquidated by the trustee in order to obtain funds for the creditors, in some cases the cost of liquidating the asset may exceed its value. As a result, the trustee may allow the debtor to keep certain items of non-exempt property that have little market value, in which case they are deemed abandoned back to the debtor. In the alternative, the trustee may permit the debtor to purchase the items from the estate.
Similarly, where the value of an asset exceeds the amount of the debtor's exemption -- effectively meaning that part of the asset's value is exempt, but part is non-exempt -- the trustee may give the debtor the opportunity 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. That is a dangerous assumption, and when discovered may subject the debtor to consequences including the loss of any exemption associated with the asset, 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 debtor's petition to dismiss a Chapter 7 bankruptcy.
Once a debtor has examined the various factors affecting whether filing for bankruptcy 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 wants to resolve certain debts that may not be discharged in a Chapter 7 bankruptcy, and will benefit from having those debts restructured into a multi-year repayment plan;
The debtor wants to protect certain cosigners on personal loans from being pursued by creditors for repayment;
The debtor wants 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 a Chapter 7 bankruptcy is pending;
The debtor feels morally obligated to repay certain debts;
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 has obtained a Chapter 13 bankruptcy discharge within the prior six years 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.
Although individual debtors are technically eligible to file Chapter 11 bankruptcies, the cost of a Chapter 11 proceeding is very high. Realistically speaking a consumer debtor will only consider that option if they have a very high debt load and are ineligible to file either a Chapter 7 or Chapter 13 bankruptcy.
Some debtors discover after filing a Chapter 7 bankruptcy petition that they would be better served by obtaining relief under Chapter 13. For example, certain debts that are not dischargeable under Chapter 7 may be included in a Chapter 13 repayment plan. If a debtor owes taxes, owes money on a guaranteed student loan, or owes child support arrears, the debtor may benefit from being able to pay those debts in installments over the course of a Chapter 13 repayment plan, even if those debts are not fully repaid during the term of the Chapter 13 plan.
If a 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 convert 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 of approval.
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 may be surrendered to the trustee, who will sell those assets to pay your creditors;
You will be allowed to keep some personal property, and probably an interest in your home (although perhaps not all of your equity), with the amounts you can keep depending upon the exemptions applicable in your state.
Most debts are cancelled by the bankruptcy court's order of discharge.
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 that either of those exclusions apply to you, you should discuss your case with an attorney as you may qualify for an exception.