What Is Chapter 7 Bankruptcy?

Chapter 7 Bankruptcy Explained

Chapter 7 Bankruptcy: What to Know. Also called straight bankruptcy or liquidation bankruptcy. Court appoints a trustee to take your assets, sell them and distribute the money to the creditors, who file proper claims. You're allowed to keep enough "exempt" property to get a "fresh start"

Image by Adrian Mangel © The Balance 2019

Chapter 7 bankruptcy eliminates most debt through the liquidation of assets. 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, and distribute that money to your creditors.

Eliminating debt is an important step toward achieving financial freedom. If you are considering filing for Chapter 7 bankruptcy, find out what you need to know.

What Is Chapter 7 Bankruptcy?

Chapter 7 bankruptcy eliminates most debt through the liquidation of assets. It's the most common type of bankruptcy filing in the U.S.

  • Alternate names: straight bankruptcy, liquidation bankruptcy

Important

While filing for Chapter 7 bankruptcy can help you get a "clean slate" in your financial life, remember that it will stay on your credit report for 10 years.

How Chapter 7 Bankruptcy Works

In Chapter 7 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, and distribute that money to your creditors. Creditors must submit proper claims to receive payment.

However, 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:

  • Residence/homestead
  • Auto
  • 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. In fact, many Chapter 7 cases are considered to be "no asset" cases because there's little or nothing left for the trustee to sell or liquidate after exemptions are applied.

Note

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.

Chapter 7 Bankruptcy vs. Chapter 11 Bankruptcy

Because there are several different bankruptcy filing types, it's important that you're choosing the best option for you and your future financial situation. Consider the key differences between Chapter 7 and Chapter 11 bankruptcy.

Chapter 7 Bankruptcy Chapter 11 Bankruptcy
Known as "liquidation" or "straight" bankruptcy Known as "reorganization" or "rehabilitation" bankruptcy
More often used by individuals to help repay debts More often used by businesses to help repay debts while continuing operations
Process generally takes four to six months Process can last years

How to Prepare for Chapter 7 Bankruptcy

When it's time to prepare for Chapter 7 bankruptcy, 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.

Tip

Visit the federal court locator page, choose "Bankruptcy" under "Court Type," and add your location in the bottom box to find your local court.

Credit Counseling

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. 

Understanding 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

When a Chapter 7 bankruptcy is filed, 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. 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, the only creditors who typically may appear are auto lenders to ask what you intend to do about your car payments, if you have them.

Note

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 on 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 before 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.

Key Takeaways

  • Chapter 7 bankruptcy eliminates most debt through the liquidation of assets by a trustee. It's the most common type of bankruptcy filing in the U.S.
  • 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.
  • People who file for Chapter 7 bankruptcy will need to receive credit counseling, pass the means test, and attend the meeting of creditors.
  • The bankruptcy court will automatically grant a discharge if the trustee and the creditors don't object on supportable grounds.