What Is Chapter 7 Bankruptcy?
Making ends meet can be difficult, and people sometimes find that they simply can't do it. Imagine how liberating it would be if you could call up a magic genie from a bottle and wish for your debt to simply vanish. It's not quite that easy, but federal bankruptcy laws can help you manage or eliminate debt. Chapter 7 bankruptcy eliminates most debt. It's the most common type of bankruptcy filing in the U.S.
Chapter 7 Bankruptcy Explained
Chapter 7 is often referred to as a "straight" or "liquidation" bankruptcy. The court appoints a trustee to oversee your case, and part of the trustee's job is to take ownership of your assets, sell them, then distribute to your creditors the money that's been raised. Creditors must submit proper claims to receive payment.
Creditors might not—and rarely do—receive all that you owe them. Most Chapter 7 bankruptcy estates don't have enough funds left after accounting for exempt property to pay everyone what they're owed. These unpaid balances are "discharged" so the debtor no longer owes that money.
The trustee can't take all your assets. You're permitted to keep certain "exempt property" so you're not stripped of everything you need to live and you have a foothold to get a fresh start.
Exemptions can refer to either federal or state statutes, and they apply to certain types of property. The federal government offers a list of exemptions, and many states have adopted their own lists. Debtors must use the state list in some of these jurisdictions, while other states allow them to choose between their own and the federal lists. Debtors can elect the set of exemptions that are most beneficial.
Common exemptions include:
- Certain retirement accounts
- Property that's necessary for work/earning a living
Retirement plan exemptions are available to everyone, even if they must accept their state's list and their state doesn't provide an exemption for such accounts.
This list is by no means exhaustive and, in fact, many Chapter 7 cases are considered to be "no asset" cases because there's nothing little or nothing left for the trustee to sell or "liquidate" after exemptions are applied.
Preparing for Chapter 7
Gather all your financial records like bank statements, credit card statements, loan documents, and paystubs. You'll use this information to complete the bankruptcy petition, schedules, statement of financial affairs, and other documents that must be submitted to the court.
You can download copies of these documents for free from the U.S. Courts website.
Chapter 7 documents include a voluntary petition for relief, schedules of assets and liabilities, declarations regarding debtor education, and a statement of financial affairs. They include listings of all of your property, debts, creditors, income, expenses, and property transfers.
You or your attorney will file everything with the clerk of your local bankruptcy court and pay a filing fee.
Visit the federal court locator page, choose "Bankruptcy" under "Court Type" and add your location in the bottom box to find your local court.
Almost every individual debtor who wants to file a Chapter 7 case must participate in a session with an approved credit counselor before the case can be filed. The session can be attended in person, online, or by telephone.
The U.S. Department of Justice provides an interactive search tool on its website to help you find approved credit counselors in your area.
The rationale behind this requirement is that some potential debtors don't know that they have other options. A credit counselor might be able to suggest alternatives that will keep you out of bankruptcy.
Most debtors will also have to take a course in financial management before they can receive a discharge. This class is often given by the same group that you used for credit counseling.
Plan to spend about two hours in person, online, or on the telephone in each class.
The "Means Test"
Debtors must also successfully pass the means test calculation, another document that must be completed when you file for bankruptcy. This test was added to the Bankruptcy Code in 2005, and it calculates whether you're able to afford or have the "means" to pay at least a meaningful portion of your debts.
The means test compares your household income with the median income for your state, and it compares your expenses to IRS Local Standards—what people typically pay for similar expenses in your area.
You can only file Chapter 7 bankruptcy under very specialized exceptions if you fail the means test. Your alternative would be to file a Chapter 13 repayment plan case. The means test calculation requires completing and submitting Official Form 122A-2 with the bankruptcy court.
The Meeting of Creditors
The court will issue notice of a debtor's "meeting of creditors," often referred to as the "341 meeting" after the bankruptcy code that provides for it, when a Chapter 7 bankruptcy is filed. This notice is also sent to all the creditors that are listed in the bankruptcy documents.
As the name suggests, any creditor can appear at this meeting and ask the debtor questions about their bankruptcy and their finances. In reality, however, the only creditors who typically might appear are auto lenders to ask what you intend to do about your car payments.
Bankruptcy court judges aren't permitted to attend the meeting of creditors. This rule is intended to ensure that they remain impartial.
The bankruptcy trustee will ask the debtor various questions at this meeting as well, such as whether all the information contained within the bankruptcy documents is true and correct. They'll determine that the debtor understands all the ramifications of filing for bankruptcy and receiving a discharge.
The trustee might continue the meeting of creditors to a future date if they want to investigate certain aspects of the bankruptcy further.
The Debtor's Discharge
The bankruptcy court will automatically grant a discharge if the trustee and the creditors don't object on supportable grounds. The last day to file a complaint objecting to a debtor's discharge is 60 days after the meeting of creditors, or after the date of the first meeting if it's continued and carried over to another date or dates. The discharge is usually entered several days later if no complaint is filed.
The discharge prevents creditors from attempting to collect any debt against you personally if it arose prior to the filing of the bankruptcy.
Some debts, including certain taxes and child or spousal support obligations, aren't dischargeable. They'll survive the Chapter 7 proceedings and you'll still owe them.
A creditor can also still collect on a discharged debt from a co-debtor if someone signed on the loan or debt with you and didn't file for bankruptcy.
United States Courts. "Chapter 7 - Bankruptcy Basics." Accessed Feb. 16, 2020.
National Consumer Law Center. "Increase of Federal Bankruptcy Exemptions, Other Dollar Amounts: April 1, 2019." Accessed Feb. 16, 2020.
Debt.org. "Chapter 7 Bankruptcy." Accessed Feb. 16, 2020.
United States Department of Justice. "Means Testing." Accessed Feb. 16, 2020.