Crucial Question: What is Chapter 7 Bankruptcy?

Wasson and ThornhillChapter 7

Chapter 7, sometimes called “straight bankruptcy,” is the simplest type of bankruptcy, yet it can also handle not-so-simple debt problems.

 

The Most Common Type of Bankruptcy

Chapter 7 bankruptcy is what most people think of when they hear “consumer bankruptcy.”

More Chapter 7s cases by far are filed than under any other Chapter. In 2013, about 68%—a little more than 2/3rds—of all bankruptcies filed in the U.S. were Chapter 7s. About 31% were Chapter 13 cases (“Adjustment of Debts of an Individual”), with the remaining less-than-1% being Chapter 11s (business “Reorganization”) and Chapter 12s (“Adjustment of Debts of a Family Farmer or Fisherman”)—along with a handful of Chapter 9s (“Adjustment of Debts of a Municipality”).

In some places Chapter 7s were even more prevalent. For example, last year in Arizona about 86% of all cases filed were Chapter 7s while in Idaho about 91% were.

A total of 728,833 Chapter 7 cases were filed last year. That’s more than the entire population of San Francisco, Atlanta, Detroit, or Boston.

What a Chapter 7 Bankruptcy Accomplishes

It is often the quickest way to a financial fresh start. In a straightforward case your debts are discharged (legally written off) about three months after the case is filed.

A Chapter 7 case discharges most of or all of your debts. Certain kinds of debts—such as child or spousal support obligations owed to an ex-spouse under a divorce decree or settlement—are never discharged under Chapter 7. Some other debts—such as income taxes—can be discharged if they meet certain conditions. Student loans can very rarely be discharged.

And you may not want to discharge some debts with collateral like your home mortgage or vehicle loan.

But otherwise a Chapter 7 gets rid of most debts, and does so quickly.

What’s the Procedure for a Chapter 7 Case?

At the moment your attorney files your case, virtually all of your creditors are forbidden to take any action to collect their debts. They have to stop whatever they were already doing, and cannot start anything new.

About a month after filing, you go with your attorney to a 10-minute or so meeting with the bankruptcy trustee called—misleadingly—the “Meeting of Creditors.” There are usually no creditors present, and very seldom more than one. If there is a creditor present it’s often for a helpful purpose, such as to make arrangements for you to keep your vehicle or some other collateral. The primary purpose of the “Meeting” is to verify that you do not have any assets that are not protected from your creditors. The trustee may also briefly review other relevant aspects of your financial affairs. Some trustees end the “Meeting” by announcing that you have a “no asset” case—that none of your assets are unprotected.

If you want to keep any collateral (vehicle, furniture, home), during your Chapter 7 case you may need to formally “reaffirm” the debt with the pertinent creditor. A “reaffirmation agreement” signed and filed at court would result in that debt surviving the Chapter 7 case with you still owing it.

Each of your creditors has 60 days after the “Meeting of Creditors” to object to the discharge of its debt. The grounds for objection are narrow and so creditors seldom object. Immediately after the 60 days passes, the bankruptcy judge signs the discharge order. Your creditors are forever prohibited from trying to collect those debts from you. Unless there are any unresolved matters, the Chapter 7 case is closed.

You have your financial fresh start.

Isn’t Chapter 7 the “Liquidation” Type of Bankruptcy?

Yes, but in the vast majority of Chapter 7 cases, especially consumer ones, no liquidation whatsoever of the debtors’ assets takes place. In these cases everything the debtor owns is “exempt”—protected from the trustee and from your creditors.

In the unusual case that you do have assets that are not exempt (and you have chosen not to protect those assets through a Chapter 13 case), the Chapter 7 trustee would likely take and sell them, and pay the sale proceeds to your creditors. But realize that the trustee must pay certain “priority” debts in full before the other debts are paid anything. Often “priority” debts are ones that you would have to pay anyway—child support arrears, recent income tax debts, and such—so having the trustee do so for you may not be a bad way to go.

Can Chapter 7 Handle Complicated or High-Debt Situations?

Both Chapter 13 “Adjustment of Debts of an Individual” and Chapter 12 “Adjustment of Debts of a Family Farmer or Fisherman” have limits on the amount of debts that a debtor can have to be able to file a case under that Chapter. Chapter 7 has no debt limitation.

Chapter 13 can only be filed by an individual, not a corporation, partnership, limited liability company or any other type of business entity. Chapter 7 has no such limitation.

Out of the 728,833 Chapter 7 bankruptcies filed last year, 22,334 of them, or only about 3%, were business filings. That means that they were filed by a corporation or business partnership, or by an individual with more business debt than personal. Although the vast, vast majority of Chapter 7s were consumer cases, it CAN handle large and complicated cases. It’s not a question of the amount of debt, or business vs. consumer, but rather of fitting the right tool to your unique set of circumstances.