The Basics of Chapter 7 Bankruptcy

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The Basics of Chapter 7 Bankruptcy. Getty Images

There are several different types of bankruptcy, but the vast majority of individuals file either a Chapter 7 straight bankruptcy or a Chapter 13 repayment plan bankruptcy. In 2015, according to bankruptcy court statistics, 819,240 non-business Chapter 7 and Chapter 13 cases were filed in the United States. 

A Chapter 7 case is arguably easier, quicker and less expensive than Chapter 13. Of all the cases filed in 2015, approximately 64 percent of both cases were Chapter 7, but it also has some limitations that make it less useful for people who have gotten behind in their house or car payments or need a way to catch up on taxes, child support and other debts that cannot be handled in a Chapter 7 case.

When you file a bankruptcy case, we call you the “debtor.” The goal of most debtors is to obtain a discharge, which is an order from the court that tells the debtor’s creditors that the debtor has fulfilled all the requirements for filing a Chapter 7 case, and that in exchange, the debtor no longer has any obligation to pay the debts. (Not all debts are dischargeable, however. See below.)

To get to that point, like with any worthwhile endeavor, you will have a lot of work to do before you file your Chapter 7 case.

Credit Counseling

One of the first steps requires that you take part in special credit counseling session during which a credit counselor will review your budget to determine if you might have available other avenues for gaining control over your finances. These credit counseling sessions are offered by private, government-approved companies, usually last about an hour and usually cost about $25.

The session can easily be accomplished online (plus a short telephone check-in with a live counselor), and telephone and face-to-face options are also available. The session can easily be accomplished online (plus a short telephone check-in with a live counselor), and telephone and face-to-face options are also available.

The Means Test

In 2005, Congress passed some new laws that they said would cut down on what Congress perceived were abuses of the bankruptcy system by people who should be able to afford to pay back their debts. Thus, the means test was born. The means test is a calculation that compares your income to your reasonable and necessary expenses, also taking into consideration your family size and the median (midpoint) income for your state. The means test tells us whether you could pay your debts in part and would be presumed to be abusing the system if you filed a Chapter 7 case. It does not prohibit you from filing a Chapter 7. But you would likely have to show the court that you had special circumstances that make a Chapter 7 the right choice for you.

The Schedules

All bankruptcy cases are filed in special federal bankruptcy courts. To start a Chapter 7 case, you file a petition and supporting documents, including schedules that list all your debts, assets, income, expenses, exempt property, and other aspects of your financial life. You will provide a lot of personal information to the court. The schedules can be 60 pages or more of information. All of the information must be complete, true and correct to the best of your knowledge.

You will sign them under “penalty of perjury,” similar to swearing an oath in court.

Exemptions

All of the paperwork you file will be important, but one of the most important is the schedule of exempt property. Modern bankruptcy is founded on the principle that discharging your debts will give you a “fresh start.” To make the fresh start possible, a bankruptcy case cannot leave you destitute. You are allowed to keep the property you will need to start over. That property is called exempt property. The types of property and the value of the property that can be exempted vary by state, but in every case, it will include some amount of equity in a homestead, household goods, clothing, vehicles, tools of the trade and other basics.  

The Judge and the Trustee

When your case is filed, it is assigned to a bankruptcy judge and to a trustee.

Chances are very good that you will go through your entire case without ever appearing in a courtroom before the judge. The trustee is appointed to oversee the case, particularly the assets. If you have assets that could be sold to pay creditors, the trustee is the one to do that.

The Meeting of Creditors

About a month after your case is filed, you and your attorney will meet with the trustee at what is called a meeting of creditors or a Section 341 meeting. Ironically, creditors rarely attend the meeting of creditors but it does give the trustee a chance to clarify any questions she may have about your assets and your financial picture. Although the meeting is not held in court, it is conducted under oath.

Nondischargeable Debt

Although most debts can be discharged in a Chapter 7 case, not all debts are dischargeable. The bankruptcy code lists a number of different types of nondischargeable debt. Some of the more common ones include recent taxes, child support and other domestic support obligations, debts that arise through fraud or because of an accident that occurs while you are under the influence of drugs or alcohol. Some debts can be discharged, but the discharge is not automatic. Student loans, for example, are dischargeable but you would have to show that you will suffer extreme hardship if you are forced to pay them back. Another type of debt that can be nondischargeable is any credit charges that you make shortly before you file the bankruptcy. Those will be discharged unless the creditor files an adversary proceeding, which is a lawsuit within the bankruptcy case, asking the court to declare the debts nondischargeable.

60-day Waiting Period

After the meeting of creditors, the bankruptcy code requires a 60-day waiting period before the discharge order can be entered by the court. The purpose of the waiting period is to give the trustee, creditors and other interested parties a chance to review the case to determine if further action will be required. You, as the debtor, could use that time to consider whether you will file an adversary proceeding to ask the court to declare a debt discharged. A creditor would use that time to consider and file an action to have its debt declared nondischargeable. For the trustee, further action could include taking possession of nonexempt property, objecting to your claimed exemptions, or challenging your entire discharge. The trustee and the creditors can petition the court to deny you a discharge if you committed fraud on your creditors before or during the bankruptcy and for other reasons.

Reaffirmation and Redemption

Most of your debts are probably unsecured, meaning that you did not put up any collateral that you could use if you fail to repay the debt. Some debts are secured because hey are backed by collateral. Think of car and home loans. A Chapter 7 bankruptcy will discharge those secured debts as well as your credit cards and medical bills. But it will not discharge the obligation to turn over the collateral. Therefore, you could discharge the debt to your car creditor, but the creditor would still have the right to take your car to pay off at least a part of the debt. If you want to keep the car you have two choices under the bankruptcy code. You can choose to have the debt survive the bankruptcy. This is called a  reaffirmation agreement. Under the reaffirmation agreement, you will continue to make payments. If at any time you stop making payments, the creditor will have the right to repossess the collateral or foreclose on the mortgage.

As an alternative, you can choose to redeem the property. To redeem property, you pay the creditor the value of the property as of the day you filed bankruptcy. This can be a significant cost savings over paying the debt out with interest over time, especially if the property has lost a lot value since you originally financed it. Almost always, the creditor will require that you pay the value in a lump sum.

Any reaffirmations or redemptions have to be in place before the discharge is entered.

Debtor Education Requirement

In addition to the credit counseling you take before the case is filed, you will also have to take a financial management course before your debts can be discharged. This course, which usually lasts about two hours, will be available from the same company that offers the credit counseling session for about $25.

Discharge Order

After the 60-day waiting period is over the court will issue a discharge order, provided neither the trustee nor any creditors filed an adversary proceeding or took any other action that could interfere with the discharge. Even if an adversary proceeding is pending on to determine the dischargeability of a particular debt, the discharge can still be entered.

Post-Discharge

For most people, the issuance of the discharge order is the end of the case. It everything goes according to plan, the case will last four to six months.

If the trustee is taking possession of property, the case will stay open a lot longer. Many times, the trustee will require the cooperation of the debtor. In any event, the trustee will have to gather the property and sell it or otherwise liquidate it. The court will notify creditors to file claims, which will include the amount outstanding and any documentation that supports the claim, like cardholder agreements, promissory notes, ledgers, etc. The trustee will examine the claims. If any are filed improperly, are supported with documentation, are for unexpected amounts, the trustee can object to the claim. The creditor will then have an opportunity to supplement the claim. Any unresolved or unsettled objections can be litigated before the bankruptcy judge.