Chapter 7 Bankruptcy

A chapter 7 bankruptcy is also known as a debt liquidation. It wipes out all of the debt that the law permits to be discharged.

Chapter 7 bankruptcy is designed as an orderly, court-supervised procedure by which a trustee collects the assets of the debtor(s), reduces them to cash, and makes distributions to creditors, subject to the debtor’s right to retain certain exempt property and the rights of secured creditors.

Because there is usually little or no nonexempt property in most Chapter 7 cases, there may not be an actual liquidation of the debtor’s assets. These cases are called "no-asset cases." Usually a debtors with assets that they wish to keep and that are not covered by exemptions file Chapter 13 bankruptcy.

Home Mortgages, Car Loans, and Other Secured Debt

When you borrow money and give the lender a mortgage or lien on your property, you have a secured debt. If the money you borrowed was used to purchase the secured property, the lender is entitled to recover the security if you file a chapter 7 bankruptcy.

The debt will be discharged — you will not owe any additional money to the creditor — but unless you take additional steps, you will lose the property. If you have a mortgage loan, the lender will eventually be allowed to foreclose your mortgage. If you took out a car loan and gave a lien on the car to the lender, the lender will eventually be able to repossess the car. You can always choose to surrender the property rather than dealing with the hassle of a foreclosure or repossession.

You do have alternatives under chapter 7 that allow you to keep your secured property. Before you file your chapter 7 petition, you can negotiate with the lender to reaffirm the debt. The lender might be willing to extend your loan so that the payments are more affordable. The lender might also be willing to rewrite the loan to include delinquent payments in the new loan balance.

If discharging your other debts will free up the funds you need to make payments on your secured debt, the lender might agree to reaffirm your loan despite your bankruptcy filing. It is important that you negotiate with your lender before you file bankruptcy, because it is more difficult to negotiate the terms of a reaffirmation agreement after you file your chapter 7 petition.

Another alternative allows you to keep your property if you pay its current value to your lender. For instance, if you owe a $5,000 balance on a car that is only worth $2,000 due to depreciation, you can keep the car by paying a lump sum of $2,000 to your lender.

Unsecured Debt

Most debts you owe that are not secured by collateral, including most credit card debt, can be fully discharged in a chapter 7 bankruptcy. Some loans for which you gave collateral might also be treated as unsecured if you did not purchase the collateral with the loan proceeds.

Debts That Cannot be Discharged

Some debts cannot be discharged in a chapter 7 bankruptcy, including most taxes, judgments for damages resulting from drunk driving accidents, alimony and child support arrearages, and (except in rare instances) student loans.

The Bankruptcy Estate and Exempt Property

Unless it is "exempt," all property you own (and all property your spouse owns if you file jointly) becomes part of the bankruptcy estate. The bankruptcy trustee assigned to your case can sell property in the bankruptcy estate and use the proceeds to pay your creditors.

State and federal laws define the property that is exempt. You can keep exempt property. Most states allow you to keep a certain amount of equity in your home. You can usually keep one or more vehicles up to a specified value. Household goods, clothing, and personal effects of ordinary value are usually exempt, along with a certain amount of cash. Since exemptions vary from state to state, you need to consult with your bankruptcy attorney to determine which exemptions apply to you. In many cases, debtors who file a chapter 7 bankruptcy can keep everything they own.

Before You File a Chapter 7 Bankruptcy

After you consult with your bankruptcy attorney, you can begin to plan the steps you need to take to file a chapter 7 bankruptcy. Before you file, you need to:

  • Make sure you are eligible. Only debtors who can pass a "means test" qualify for a chapter 7 bankruptcy. Your attorney can help you perform the calculations to determine whether you are eligible to file under chapter 7.

  • Plan the timing of your bankruptcy. Sometimes it makes sense to delay filing bankruptcy, particularly if delay will allow you to keep a tax refund.

  • Negotiate to reaffirm secured debts. If you have a mortgage and want to keep your home, or if you want to continue making payments on a car loan so you can keep your car, you need to negotiate a reaffirmation agreement before you file your chapter 7 petition.

  • Attending credit counseling. With the six months prior to the date on which you file bankruptcy, you must attend credit counseling provided by an approved credit counseling agency. Consult your bankruptcy attorney so you can avoid credit counseling services that will try to sell you services you don’t need.

  • Prepare the bankruptcy petition. You will work with your attorney to prepare a bankruptcy petition to file with the court. In the petition, you will list all of your income and debts. You will also list all of your assets and their approximate value. If you claim an asset is exempt from inclusion in the bankruptcy estate, you must specify the exemption in the petition.

Chapter 7 Bankruptcy Procedure

The chapter 7 petition is filed with the Clerk of the Bankruptcy Court. This is what you should expect after you file your petition:

  • Entry of automatic stay. As soon as the petition is accepted for filing, an automatic stay goes into effect. The Bankruptcy Court mails notice of the stay to each creditor you listed in your petition. The stay prevents your creditors from making further efforts to collect the debt from you unless they can persuade the court to lift the stay.

  • First meeting of creditors. A few weeks after you file the petition, you and your attorney will attend a meeting with the bankruptcy trustee appointed to your case. The trustee will ask you some questions about your petition to verify that it is accurate and complete. Your creditors are entitled to attend the meeting and to question you, although they rarely do so unless they suspect that you are hiding assets or committing some other form of fraud. Typically, your participation in a First Meeting of Creditors will last only a few minutes.

  • Review claims of creditors. Your creditors must file a claim with the court if they want to get paid. If you object to the amount of the claim or dispute the debt, you can file an objection that the trustee or the Bankruptcy Judge will resolve.

  • Adversary proceedings. In rare cases, a creditor might challenge your right to discharge a certain debt, or there might be a dispute about the value of certain property or your right to claim an exemption. In those cases, the court will hold a hearing to resolve the dispute.

  • Debtor education course. Within 60 days after you file your chapter 7 petition, you must attend a debtor education class. The class teaches you how to live within a budget and how to manage debt responsibly.

  • Wait for your discharge. A few months after you file your chapter 7 petition, the court will enter an order that discharges all of your dischargeable debts. You can then take advantage of your fresh start, free from the burden of unmanageable debt.