Chapter 7 bankruptcy is generally an avenue for relieving debt burden selected by those who cannot pay off a large amount of what they owe; commonly, this debt belongs to unsecured lenders such as credit card companies.  According to Chapter 7 of the Bankruptcy Code, there are provisions for “liquidation” as a means of raising money to pay down debts, which can mean the sale of a debtor’s nonexempt property.  In addition, Chapter 7 outlines the distribution process of proceeds from those sales to various creditors.

By contrast, Chapter 13 bankruptcy involves more of a “reorganization” of a person’s debt.  You can learn more about Chapter 13 here.  For now, it’s important to recognize the difference between Chapter 7 and 13 as mainly: Chapter 7 focuses more on a liquidation process to pay off as much debt as possible and then discharge the remaining; Chapter 13 gets more into realigning and reorganizing a person’s debts and financial plans for repaying of as much of the debt as possible until it is paid off over a period of time.

Chapter 7 Bankruptcy Background Information

A Chapter 7 bankruptcy case does not include filing a plan of repayment as you would expect to happen in Chapter 13 cases.  Rather, a trustee gathers and eventually sells the debtor’s nonexempt assets. The proceeds from all those sales are designated for paying the appropriate creditors in compliance with the Bankruptcy Code. The trustee will see to it that certain “nonexempt” assets are protected but at the same time will liquidate many of the debtor’s remaining assets.  In any case, filers need to be aware that Chapter 7 might, and often does, lead to a loss of property.

It is also important to know that a “bankruptcy estate” will be created, under Chapter 7 terms, to serve as a separate legal entity to the debtor.  The court-appointed trustee will then oversee the management of that estate during the process of handling the debt, including releasing some obligations, making repayment schedules, and overseeing other procedures related to solving the consumer’s debt.

There are some similarities to how trustees function for both Chapter 7 and Chapter 13 codes. Yet many of the distinctions boil down to the difference between each type of bankruptcy filing. Regarding Chapter 7 bankruptcy, the following are some of the primary duties and powers of a trustee when handling the liquidation part of the bankruptcy process:

  1. The trustee oversees the rounding up of all the debtor’s property
  2. The trustee remains in charge of selling off the bankruptcy estate’s property;
  3. The trustee makes decisions regarding the challenging of creditors’ claims, when appropriate
  4. The trustee is placed in charge of distributing proceeds from liquidation to creditors; and
  5. The trustee remains in charge of objecting to a bankruptcy discharge when evidence appears that a discharge would be inappropriate.

Who is eligible for Chapter 7 filing?

To qualify for relief under Chapter 7 of the Bankruptcy Code, the debtor doesn’t necessarily need to be an individual or citizen. He can be either an individual, a partnership, or a corporation, or he can represent another business entity. Subject to the result of a means test created for individual debtors, a debtor can gain relief under Chapter 7 regardless of the amount of debt the person owes or whether the debtor is solvent or insolvent. In addition, no person can be considered a debtor under Chapter 7 or any Chapter of the Bankruptcy Code unless that person has received the required credit counseling from an approved credit counseling agency within 180 days prior to filing. If a debt management plan was developed during the required credit counseling period, it must get filed with the court.  Also, the debtor needs to make sure the credit counselor he selects is officially accredited according to the Bankruptcy Code.

The previously mentioned “means test” is another step in the bankruptcy process that needs more explanation.  Basically, any debtor who wishes to qualify for Chapter 7 proceedings must successfully pass this means test, as federally created and mandated.  This test was added to the Bankruptcy Code in 2005. It calculates whether you can afford or have the sufficient “means” to pay off at least a significant portion of your debts.

Basically, the means test will compare what the debtor earns with the median income for his specific state. If a person fails the means test, he or she can only file for Chapter 7 bankruptcy under certain, specialized exceptions.  One alternative the filer can choose is to file a Chapter 13 repayment plan case. To learn more about the means test and the criteria it uses, a prospective filer can visit the U.S. Trustee website.

What are the next steps?

Meeting of Creditors

After someone files a Chapter 7 bankruptcy, the court will call for a meeting of creditors, those entities who hold a financial obligation from the debtor. The notice will go out to all the creditors listed within the bankruptcy documents that were filed with the court. During this meeting of creditors, the appointed trustee will ask the debtor various questions about his bankruptcy situation, including whether all of the information reported inside the bankruptcy documents are true and correct.

Collection of Assets and Property

If the debtor owns any non-exempt property, the bankruptcy trustee has the power to seize and sell off that property.  Property can be considered exempt if federal or state statutes allow you to protect certain kinds of property as you file for bankruptcy.   A prime example of an exempt possession are retirement accounts, such as a 401(k) plan, which are not affected during the Chapter 7 bankruptcy process when other nonexempt property is sold off.

Any assets that the trustee was able to recover are eventually distributed to the appropriate creditors.

Financial Management Counseling

Before the court will grant a discharge to the debtor, he or she must take a course involving financial management.  The class will usually be taught by the same group that provided the credit counseling and must be officially accredited according to the Bankruptcy Code. The whole course generally consumes about 90 minutes -give or take -for each person who takes it and can be taken online.

Restrictions of Chapter 7 Bankruptcy

The ultimate objective of taking the above steps is to be granted a discharge. However, remember that not all debts are dischargeable, including child support, specific taxes, and several other categories that can be considered obligations (debt).  Also, collateral can be used as a means to settle some of a person’s debt amount.  In any case, legal experts such as attorneys can play a vital role in helping a person navigate the intricate, paper-intensive waters of bankruptcy.