Bankruptcy Overview: Chapter 7
An individual may choose to file for either a Chapter 7 bankruptcy or a Chapter 13 bankruptcy. While a Chapter 13 bankruptcy reorganizes debt into a repayment plan, a Chapter 7 bankruptcy, also known as a "liquidation" bankruptcy, discharges all debt that is legally capable of discharge. Chapter 7 bankruptcy rules determine who qualifies, how to file, and what debt is eligible for discharge.
Qualifying for Chapter 7 Bankruptcy
Income criteria established by bankruptcy law determine which debtors may file for Chapter 7 bankruptcy. In order to qualify under income guidelines, a filer's income must be equal to or fall below the median income in the filer's state. Every state has different income guidelines. A filer that falls within a state's income criteria may file for Chapter 7.
However, if the filer's income is above the state's median, the bankruptcy court will require the filer to take a "means test" in order to establish eligibility for Chapter 7. The means test prevents filers with the ability to repay creditors from discharging debt. The means test assesses the filer's debt and income from the preceding six months. If the debtor has a certain amount of income leftover every month after paying creditors, the debtor will fail the means test. Although the debtor is ineligible for Chapter 7, Chapter 13 is an option. A Chapter 13 bankruptcy allows the debtor to repay creditors in a five-year repayment plan.
Who is Ineligible for Chapter 7 Bankruptcy
Under Chapter 7 bankruptcy rules, a debtor is ineligible under the following circumstances:
•A previous debt was discharged within the past eight years under Chapter 7;
•A previous debt was discharged within the past six years under Chapter 13;
•Their income, expenses and debt would allow for a Chapter 13 filing;
•The debtor attempted to defraud creditors or the bankruptcy court; or
•The debtor failed to attend credit counseling.
How to File for Chapter 7
A debtor must attend credit counseling prior to filing for Chapter 7. Upon completion of credit-counseling with an agency approved by the United States Trustee, the debtor can file for bankruptcy with a local bankruptcy court. The cost for filing is $306. A debtor is required to provide information about income, debt, expenditures, creditor holdings of secured and unsecured debt, the sale of prior property, and a list of exempt property. Exempt property is property that Chapter 7 bankruptcy rules allow a debtor to keep. Each state has its own guidelines, but exempt property typically includes clothing, furniture, and cars.
The Automatic Stay
Once a debtor files for bankruptcy, the bankruptcy court will issue an automatic stay, or an "Order for Relief." An automatic stay protects a debtor from a creditor's attempt to collect on a debt during the bankruptcy process. In effect, all collection activities, including any pending lawsuits, must cease. An automatic stay will prevent wage garnishment, filing of liens, and the seizure of a debtor's property such as a house, a car, or a bank account. If the bankruptcy court dismisses a case, the automatic stay also terminates and the creditor may commence collection activities.
The Role of the Trustee
The trustee is responsible for liquidating any assets that the debtor possesses in excess of the allowed exemptions and distributing the proceeds to the creditors.
The Creditors Meeting
After a debtor has filed the necessary paperwork for a Chapter 7 bankruptcy, the trustee will schedule a creditors meeting. At the meeting, the trustee will review the paperwork and gather any other necessary information. If a debtor fails to attend the meeting, the trustee may make a motion to dismiss the debtor's case. Other reasons for dismissal by the trustee may include the debtor's failure to provide a copy of income tax returns at least seven days before the creditors meeting or the failure to file a current income tax return.
In most cases, this creditors meeting is the only time the debtor will have to go to the courthouse.
If the trustee determines that a debtor is in possession of nonexempt property, the debtor may have to either give up the property or supply the trustee with money in the amount of the property's value. Sometimes, though, if the property doesn't have much value or would be too difficult for the trustee to sell, trustees will occasionally "abandon" the property, essentially allowing you to keep it despite the fact that it is nonexempt.
The Discharge of Debt under Chapter 7
A few months after the creditors meeting, the bankruptcy court will hold a discharge hearing. A debtor's unsecured debt, debt that is unsecured by property, is discharged. Secured debt, such as a car loan or a mortgage, receives different treatment. At the beginning of the bankruptcy process, the debtor selected to do one of the following: pay the creditor for the replacement value of the property, return the property to the creditor, or "reaffirm" or agree to new contract terms with the creditor.
Under Chapter 7 bankruptcy rules, the debtor must repay some debt. The following debt remains after a bankruptcy discharge:
•Tax debt, unless a debtor meets the criteria to discharge federal tax debt
•Student loans, unless a bankruptcy court determines that undue hardship exists
•Debt created by fraudulent means
Once a discharge of debt occurs, creditors can no longer attempt to collect the discharged debts.