Sometimes under Chapter 7, some or all of your debts are partially paid through non-exempt assets, and the remaining amounts written off.
Our last blog post was about what happens to “general unsecured” debts in a straightforward Chapter 7 “straight bankruptcy” case. This type of debts is usually “discharged”—legally permanently written off—without you needing to pay anything on them.
But under some circumstances a PORTION of those run-of-the-mill debts DO need to be paid in a Chapter 7 case. Understanding how this works will help you decide between doing a Chapter 7 case or instead a Chapter 13 “adjustment of debts” one.
Property Exemptions and Chapter 7 “Asset Cases”
When consumers file a Chapter 7 case, most of the time they get to keep everything they own. That’s especially true when they are represented by an experienced Louisville bankruptcy lawyer. The reason they can keep everything is that everything they own is protected by property exemptions.
Property exemptions are legal protections of your assets, usually expressed in maximum dollar amounts for each set of assets. For example, you can usually protect a certain amount of equity in your home through a homestead exemption, a certain value in a vehicle through a vehicle exemption, etc. These property exemptions differ from state to state, often significantly.
What happens if you own an asset that is not exempt? The Chapter 7 trustee has the option of taking it from you, selling it, and distributing the proceeds among your creditors. That doesn’t always happen. If the asset has little value, or is not worth the effort for some other reason, the trustee can decide to abandon it. (See Section 554 of the Bankruptcy Code.)
If a Chapter 7 trustee DOES NOT take possession of any assets, the case is called a “no asset case.” If the trustee DOES take possession of assets to sell, it’s called an “asset case.”
Let’s look at two examples of Chapter 7 “asset cases.”
“Asset Case” Example
In the first example let’s assume that based on your income and other factors you qualify for Chapter 7 bankruptcy. You owe $100,000 in a combination of credit cards, medical bills, and personal loans. These very likely all fall into the category of “general unsecured” debts. You have no other debts.
Assume also that just about everything you own is protected by property exemptions. Except that you own a boat worth $5,000. It used to be important to you but is now more of a bother considering what it costs to maintain. Assume that it’s not protected by a property exemption.
In the Chapter 7 case you would give the trustee the boat, who would sell it, say, for $5,000. Let’s say the trustee had to spend $500 in expenses—for advertising the sale, and boat moving and storage fees. The trustee also gets paid, with court approval, a maximum of 25% of the amount disbursed to creditors. (It’s actually 25% on only the first $5,000 disbursed, and then a sliding scale of lower percentages as the amount disbursed increases. See Section 326 of the Bankruptcy Code.)
Here the amount for the trustee is $900, leaving $3,600 for the creditors. The trustee pays out that $3,600 proportionately to the $100,000 in debts. So your creditors would receive 3.6 cents for each dollar owed. And the remaining balances on all the debts would be completely discharged.
“Priority” Debt Example
In the second example take the same facts but add one more debt—$4,000 owed in last year’s income taxes to the IRS. That is a “priority” debt, one that bankruptcy law says the trustee must pay in full before the “general unsecured” debts are paid anything.
So in this example the Chapter 7 trustee would sell the boat for $5,000, pay the $500 in expenses out of that and keep $900 in trustee fees. But now the remaining $3,600 would all go to the IRS, leaving nothing for the “general unsecured” debts.
Income taxes from last year cannot be discharged in bankruptcy, so you would owe the remaining unpaid portion of $400. ($4,000 minus $3,600 = $400.) But that’s a whole lot better than owing $4,000! You or your lawyer would contact the IRS to make payment arrangements, in small monthly payments if necessary.
And what happens to the $100,000 in “general unsecured” debts which received nothing from the boat proceeds? They are all discharged without you having to pay anything on them.