The fate of nonexempt assets in a Chapter 7 case
Or, what happens to my shirt if I lose it (literally)?
One of the biggest myths about filing bankruptcy is that you'll have to give up everything. I hate to break it to you, but that's just not true. Here's what really happens.
When you file a bankruptcy case, you must list everything you own. All of that property becomes part of the "bankruptcy estate" when you file a bankruptcy case. You are allowed to keep certain types of property so that you will have something with which to launch a "fresh start" after the bankruptcy is over. The property you're allowed to keep is called "exempt" property, or exemptions. You can learn more about exemptions here: Bankruptcy Exemptions.
Examples of Nonexempt Assets
These are assets that don't fall within any exemption category. They are, at least theoretically, to be turned over to the Chapter 7 Trustee for liquidation - turned into cash to be distributed to creditors.
In reality, though, not all nonexempt assets are useful to the trustee. Some of those assets are just too difficult to sell, or they cost too much to maintain until they sell, or just aren't worth enough.
The asset is too expensive to maintain.
Take for instance, Beth's collection of rare Civil War documents. She thinks they're worth about $20,000, but it costs her $5,000 a month to store them in secure climate controlled vaults. Yes, a trustee might make $15,000 on the sale, if he acted quickly, but that isn't likely to happen. Every sale in a bankruptcy case has to be approved by the bankruptcy court after all parties have had a opportunity to object or come up with a different plan (all in the name of getting top dollar.) So, the trustee is looking at a process that might take two or three months to accomplish.
In the meantime, the cost of maintaining the asset is borne by the bankruptcy estate.
The asset will take too long to sell.
Marnie restores vintage golf carts to pristine condition then sells them on eBay. He usually makes a nice profit, but they take six months or more to find a buyer. He has four on hand when he files Chapter 7. The trustee isn't willing to wait six months for buyers to show up, especially considering that he's likely to sell the golf carts for a significantly discounted price.
The asset would be hard to sell.
Perhaps the asset is too personal to the debtor. Consider Joe. Joe makes all his money from freelance writing and he gets most of his business through his website at www.joethefreelancewriter.com. (Yes, the website is an asset of the business and should be listed as an item of Joe's property). The website is positioned high in search engine results and gets Joe lots of business. It has a lot of value to Joe. Would it have much value to a trustee trying to sell it, especially if you consider that the business itself requires Joe's services to make things happen?
The asset's value is too small.
Don doesn't have any exotic assets, but he has been restoring his rusted out old Corvette, currently on blocks. He thinks it's worth about $2,000. Even though it's not exempt, the trustee isn't likely to touch it. Why? Because it won't generate enough cash. In fact, a bank account of $2,000 would not likely attract much interest from the trustee. The trustee gets paid a commission based on what passes through a bankruptcy estate he's been appointed to administer. For instance, on his first $5,000, he only makes 25%.
If he sold the Corvette for $2,000 he'd make $500, but the costs of the sale, let's say $200, would come out of the remaining $1,500. That leaves $1,300 for creditors. Then, he'd have to solicit claims from creditors, and maybe even challenge some of those claims if he found them lacking. All for $500. In my experience, a trustee would have to have access to liquidated assets of about $5,000 before he would bother with them.
Check out the duties of a trustee at Who is a Bankruptcy Trustee?
So What Happens to All That Property?
The trustee files a notice with the bankruptcy court that he intends to abandon it - meaning that the property reverts back to the debtor.
But what happens if the trustee wants to liquidate an asset that the debtor really, really wants to keep? Simply, the debtor can buy it from the trustee.
So, everyone thinks they'll lose their shirts if they file bankruptcy. But, no. Chances are you will not lose your shirt - literally. Under every conceivable exemption scheme, state or federal, clothing is exempt. Unless, of course, you're talking about fur coats and diamond encrusted underthings from Victoria's Secret.
You can learn more about trustees and how much money they make by visiting the website for the National Association of Bankruptcy Trustees.
Updated by Carron Nicks June 2018