What Is Chapter 7 Bankruptcy?

Bankruptcy
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Are you having difficulty keeping up with your bills? Are you thinking how liberating it would feel if you could just call up a magic genie from a bottle and wish for no debt? Unfortunately, it's not quite that easy. But there are some federal laws that can help you manage or eliminate that debt. No doubt you clicked on this article because you've seen references to Chapter 7* or Chapter 13,"* and you have no idea what either is, much less how they're different.

Hopefully we can demystify some of that.

*By the way, the Bankruptcy Code, which is the federal law that governs the bankruptcy process, is divided into chapters, and each chapter is further divided into sections. That's where we get the name of each type of bankruptcy.  

In this article we explore Chapter 7, one of the types of bankruptcy an individual or a company can file. Chapter 7 is the single most common type of bankruptcy bankruptcy filed in the United States. Chapter 7 is also called straight bankruptcy or liquidation bankruptcy. It's the type most people think about with the word "bankruptcy" comes to mind. In a nutshell, the court appoints a trustee to oversee your case. Part of the trustee's job is to take your assets, sell them and distribute the money to the creditors who file proper claims. The trustee doesn't take all your property. You're allowed to keep enough property to get a "fresh start".

What you keep is "exempt" property

Preparation

Prior to the filing of a Chapter 7 bankruptcy, you will gather together all your financial records in order to fill out the bankruptcy petition, schedules, statement of financial affairs and other documents. This includes bank statements, credit card statements, loan documents, paystubs and other financial records.

It is critical to have proof that the financial information that you put on your bankruptcy documents matches your financial records. By having all your records at hand, you can quickly and efficiently comply with any requests by the trustee to verify your information.

Completing Bankruptcy Documents

Filing for Chapter 7 bankruptcy involves the completion of many documents. These documents are usually available as a packet from the bankruptcy court clerk's office for a fee. You can also download copies for free from the website maintained by the US Courts. Your attorney will use bankruptcy computer applications to produce them. Broadly, these documents include the voluntary petition for relief, the schedules of assets and liabilities, declarations regarding debtor education and the statement of financial affairs. These documents require you to open up your financial life to the bankruptcy court. They include a listing of all of his property, debts, creditors, income, expenses and property transfers, among other things. Upon the completion of all of the bankruptcy documents, you must file the documents with the clerk of the bankruptcy court and pay a filing fee.

Credit Counseling

Almost every individual debtor who wants to file a Chapter 7 case has to participate in a session with an approved credit counselor before the case can be filed.

This can be in person, online or over the telephone. The rationale behind this requirement is that some potential debtors don't know their options. A credit counselor may be able to suggest alternatives that will keep you out of bankruptcy. 

Means Test

A debtor must also successfully pass the means test calculation, which is another document that must be completed prior to filing for bankruptcy. This test, which was added to the Bankruptcy Code in 2005, calculates whether you are able to afford, or have the "means" to pay at least a meaningful portion of your debts. The means test annualizes your income for the past six months and compares it with the median income for your place of residence. The means test also includes your secured debt in determining whether you can afford to pay for your debts.

If you fail the means test, you can only file Chapter 7 bankruptcy under very specialized exceptions. Your alternative would be to file a Chapter 13 repayment plan case. The means test has drawn criticism since its inception.

Meeting of Creditors

After a Chapter 7 bankruptcy is filed, the court will issue a document giving notice of a debtor's Meeting of Creditors. This notice is also sent to all of the creditors that are listed within the bankruptcy documents. During the Meeting of Creditors, the bankruptcy trustee will ask the debtor various questions about the bankruptcy, such as whether all of the information contained within the bankruptcy documents are true and correct. The trustee may ask other questions about a debtor's financial affairs. If the trustee wishes to investigate the bankruptcy further, he may continue your Meeting of Creditors to a future date. On the other hand, the trustee may conclude the meeting on the first meeting. It is important to note that at the Meeting of Creditors, as the name suggests, any creditor may appear and ask a debtor questions about his bankruptcy and finances.In reality, however, the only creditors who appear regularly are car creditors (to ask what you intend to do about your car payments) and the IRS (to ask when you're going to pay back those nondischargeable taxes).

Seizure of Assets

If you have any non-exempt property, the bankruptcy trustee has the ability to seize and sell the property. Exemptions refer to federal or state statutes that allow you to keep certain types of property from seizure in bankruptcy or to satisfy a judgment. For example, exemptions exist to protect retirement accounts, such as a 401(k) plan. Exemptions must be set forth in Schedule C, a bankruptcy document filed by the debtor. Any assets that the trustee can recover are distributed to creditors.

Financial Management Course

Before most debtors can receive a discharge, they will have to take a course in financial management This class is likely taught by the same group that you used for the credit counseling. Plan to spend about one and a half hours in person, online or on the telephone. 

Discharge

If the trustee and the creditors do not object to the debtor's discharge, the bankruptcy court will automatically give the debtor a discharge at some point after the last day to object. The last day to file a complaint objecting to a debtor's discharge is 60 days after the first session of the Meeting of Creditors. If no complaint is filed, the discharge is usually entered several days later. The discharge prevents creditors from attempting to collect any debt against you personally, that arose prior to the filing of the bankruptcy. Thus, for all intents and purposes, the discharge effectively wipes out debts. However, it is important to note that not all debts are dischargeable, including, certain taxes and child or spousal support obligations. Furthermore, a bankruptcy discharge is personal. This means that a creditor can still collect on a discharged debt from a co-debtor that did not file for bankruptcy. A creditor with collateral may also be able to use that collateral to satisfy some of that outstanding debt.

Updated February 2017 by Carron Armstrong