Chapter 7 Bankruptcy - Bankruptcy.com

A Complete Guide to Understanding Chapter 7

As has often been reported, over fifty percent (50%) of U.S. households are living paycheck to paycheck, juggling necessary expenses and growing levels of debt. What happens when such a household has a significant negative event in their financial situation, such as an unexpected job loss, medical emergency, divorce, death in the family, etc., and can no longer keep up with their bills? This is what led the U.S. government to develop Chapter 7 bankruptcy.

Chapter 7 bankruptcy is a legal process under Title 11 of the United States Code that allows people to eliminate most or all of their debts and receive a fresh start on their finances. Commonly referred to as “total” bankruptcy or “liquidation” bankruptcy, Chapter 7 is by far the most common type of bankruptcy case filed in the U.S., making up approximately sixty percent (60%) of all bankruptcy cases filed annually.

The concept is relatively simple. A person or business who can no longer pay their debts files a set of papers known as a bankruptcy petition with the federal court. When the case is filed, the court appoints a bankruptcy trustee to oversee the case. The trustee reviews the case, liquidates (sells) any assets that the person/business has that are not protected by law, pays the proceeds to the creditors and then any debt that was not paid is discharged (eliminated), giving the person/business a “fresh start”. While it sounds simple, the bankruptcy laws and procedures can be very complex, so hiring an experienced bankruptcy attorney to represent the person/business is recommended.

To understand the Chapter 7 process, you first need to become familiar with the vocabulary:

Debtor: The debtor is the individual or business that owes money and is filing for bankruptcy protection.
Creditor: The creditors are the parties to whom money is owed by the debtor. Creditors in bankruptcy come in four main categories:
1. Secured creditors: These are creditors who hold debt that is secured by an asset, such as a mortgage against a home or a car loan against a car.
1. Priority creditors: These are creditors to whom the law has provided special treatment, such as recent tax debt, child support obligations and alimony.
1. Unsecured creditors: These are creditors who hold debt that has no collateral against it, such as credit cards, medical bills and payday loans.
1. Leases/Executory Contracts: These are creditors who have a contract with the debtor for payment that may have or may create a future debt, like renting a residence or leasing a car.
Bankruptcy Petition: This is the set of forms and schedules that must be completed and filed under oath with the federal court to start a bankruptcy case.
Exemptions: These are the laws that protect a debtor’s property from being sold in a Chapter 7 bankruptcy. Depending on the state, they can either be state or federal exemptions. Due to exemptions, the majority of cases filed are “no-asset” cases, meaning that the debtor does not lose any of their property.
Automatic Stay of Bankruptcy: This is a powerful federal injunction that is triggered by the filing of the bankruptcy case. It is this order that stops most collection activities of creditors, including wage garnishment, collection lawsuits, foreclosure and repossession on top of collection calls and letters.
Chapter 7 Trustee: This is the professional, usually an attorney, appointed by the court to oversee the case and, in the rare event that there are assets to be liquidated, conducts the sale of assets.
341 Meeting: This is the meeting that the debtor must attend with the trustee. It is usually about four (4) weeks after the filing of the case, is often conducted virtually and usually only lasts for 5-10 minutes.
Discharge: This is the order entered at the end of the case that permanently eliminates the debts.

When I was a practicing lawyer, I would often say that my clients would usually come to me several months before they really wanted to file for bankruptcy protection, but several months after they actually should have filed. Filing for Chapter 7 bankruptcy is not a decision to be taken lightly, but it is an exceptionally powerful way for a person to get their finances back under control and should be reviewed as an option as soon as one recognizes that their finances are spiraling out of control.

Now that you understand the core vocabulary, we will review the process of deciding on, preparing and filing a Chapter 7 bankruptcy case.

Before Filing Chapter 7

Before filing, most people consult with and retain an experienced bankruptcy attorney to guide and assist them through the process. Individuals have the right to file without an attorney, known as filing “pro se”, but it is not recommended. The bankruptcy laws can be difficult to navigate, and a small mistake can result in a very bad result, so having an attorney who knows the law and helps you navigate the process is very important. The attorney can ensure that you qualify for Chapter 7 bankruptcy, advise you if any of your assets might be at risk for liquidation during the process, ensure that all the requirements are timely met and ensure that the bankruptcy petition is complete and accurate.

You will need to provide some documentation to your attorney in order to prepare your case for filing. Most often this includes recent paychecks, tax returns, bank statements, proof of identity and social security number, proof of insurance on financed assets and proof of title to assets. The documents you are required to provide will depend on your specific situation.

Prior to filing, individuals are required to complete a Consumer Credit Counseling Course with an approved provider. The certificate of completion of this course will be filed with your bankruptcy petition. Your attorney will advise you on how to get this done.

Your attorney will then prepare your bankruptcy petition, which you must review and sign under oath in order to have it filed. The bankruptcy petition includes:

A schedule disclosing all of your assets and their current value. You are required to disclose every asset, even those with minimal or no value, and failure to disclose an asset can lead to a denial of your discharge or worse.
A schedule stating all of the exemptions that you claim. The exemptions are what protects the property you own and want to keep, so it is important to maximize them.
A set of schedules disclosing every creditor to whom you owe money. Again, you must list and disclose every creditor, including those that you want to continue paying, such as your mortgage or car loan.
A schedule of any people who cosigned for you or whom you cosigned for. Your bankruptcy will not discharge their obligation on the debt (other than spouses who file for bankruptcy together).
A full budget, showing all income in the household along with all of the ordinary expenses in the household. There are sources of income that can be excluded from your budget, which is another reason to hire an experienced bankruptcy attorney.
A Statement of Financial Affairs, which discloses a number of items regarding your recent financial history such as prior years’ income, recent transfers and payments, ongoing charitable contributions and payments made to professionals to try and address your financial situation.
The Means Test. This takes the last six months’ income of the household and compares it to the IRS average income for a similar household in the same geography. It is necessary to “pass” the Means Test to be eligible for Chapter 7.
A Statement of Intention, which advises how you intend to deal with your secured creditors. This is where you state that you are going to keep the car and continue making the payments on it or you are going to surrender the car and eliminate the car loan.
A disclosure of attorney compensation. What you pay to your attorney in fees and costs is subject to the review of the court and must be accurately disclosed.

Once the petition is prepared, reviewed, updated and signed, then your attorney will file the case with the federal court. The filing is almost always completed electronically.

When the case is filed, the Automatic Stay of Bankruptcy takes effect, and you are officially under the protection of the bankruptcy court. This powerful injunction requires that your creditors, with very few exceptions, stop any and all collection efforts against you. Lawsuits, wage garnishments, calls, bills, collection letters, etc. all must stop. If a creditor persists in trying to collect, your attorney can take action against them within the bankruptcy case to make them stop and potentially pay damages for their violation.

Also, when the case is filed, the court will assign your bankruptcy trustee and your bankruptcy judge. In most Chapter 7 cases, you will never have to address the judge or come to court. You will, however, have to meet with the trustee at your Section 341 Meeting of Creditors. This meeting usually happens four to five weeks after the case is filed, allowing time for your creditors to receive notice of the meeting and make arrangements to attend if they elect to. It is rare that a creditor attends this meeting, but they are permitted to appear and ask questions. 341 meetings are held virtually in almost every jurisdiction these days.

At the 341 meeting, you will be required to provide proof of your identity and social security number. The trustee will then ask you a series of questions to validate the information that you included on your bankruptcy petition and about the factors that caused you to file for bankruptcy protection. They may ask for supporting documentation regarding the value of an asset or about a recent financial transfer, but your attorney will have prepared you to respond to those requests. In the majority of cases, about 96% on average, the trustee will be satisfied that the information is true and correct and see that there are no assets to be liquidated. They will file a Report of No Distribution of Assets and that will end their role in the case.

In approximately four percent (4%) of cases where there is an asset available to the trustee, the case and the trustee’s role will last longer. The trustee will arrange to liquidate (sell) the unprotected assets in a commercially reasonable manner. They will then use the proceeds of the sale to pay the creditors as much as possible. Your attorney will advise you when you are preparing to file your case if there is an asset at risk of being sold and how you should proceed, so you will know going into the case.

After the 341 meeting, there is a sixty-day waiting period to allow the U.S. Trustee and your creditors to investigate and file any objections that they may have. The grounds for objecting are very limited and it is rare that a creditor will take any such action. Once the sixty-day window closes, the court is free to close the case and issue you a discharge.

At some point between the filing of the case and the end of the sixty-day window, you are required to take your second course, titled your Personal Financial Management Course and commonly known as “Debtor’s Education”. This course is designed to provide the basic financial foundation to ensure that you do not find yourself in a situation where you need to file another bankruptcy. It must be completed with the certificate of completion filed before the case is closed. If it is not completed timely, then the court will close your case without a discharge being granted. You may be able to file a motion to reopen the case to file the certificate of completion, but that is at the discretion of the court and there are additional court and legal fees associated with it, so it is best if you complete the course soon after filing.

With the 341 meeting held, the Debtor’s Education course completed and certificate filed, and the sixty-day waiting period ended, the court will close your case and issue you a discharge. The discharge permanently bars creditors from ever coming back to collect on the discharged debts.

Chapter 7 bankruptcy will eliminate most debts, but not all are discharged automatically and some are not discharged at all.

Secured debts: Secured debts can be discharged in a Chapter 7 bankruptcy, but this usually means that you have to surrender the collateral associated with the debt back to the lender. You can eliminate your liability on a mortgage/car loan, but this means you will lose the home/car. You can elect to keep the collateral and continue paying on the loan, as many people do. In those cases, a reaffirmation agreement is necessary, which is a legal document saying that you are electing to keep the collateral, continue paying for it and will remain personally liable for the debt.
Priority debts: Most priority debts are not discharged in a Chapter 7 bankruptcy because they are given special treatment under the Bankruptcy Code. Recent tax liabilities, child support and alimony obligations (including any arrears), fines or penalties owed to governmental entity, and debts that result from death or personal injury caused by operating a vehicle under the influence of alcohol or drugs.
Specific Unsecured debts:
1. Section 523 of the bankruptcy code lists debts that can be determined to be nondischargeable on the objection of the creditor. These include debts that were incurred using fraud or false pretenses and debts incurred due to willful and malicious conduct of the debtor.
Student Loan debt sometimes: Section 523(a)(8) generally makes student loan debt nondischargeable, however this far from absolute. Recent changes in how cases are handled have resulted in a significant amount of student loan debt being discharged in bankruptcy. In order to accomplish this, your attorney must file a mini-lawsuit in the bankruptcy called an adversary proceeding against the student loan lender and prove that not discharging the student loans would cause an undue hardship on you, the debtor. If you have student loan debt, read more here!

With the discharge entered, most if not all of your debts will have been eliminated. The stress relief of having that burden lifted is tremendous and you can focus on your fresh start. Recognize, however, that filing for Chapter 7 bankruptcy has negative impacts on you that you will need to address.

Chapter 7 bankruptcy will stay on your credit report for ten (10) years, and it is exceptionally rare that it can be removed earlier. Your credit score will have dropped substantially. You will receive a flood of offers to incur new credit but be very careful, as the interest rates and terms on these offers are generally terrible. While certainly among worst-case scenarios, a person is allowed to file for Chapter 7 bankruptcy protection again, so long as eight years has passed since the initial filing.

There are no “quick fixes” to improve your credit situation, but it is not a life sentence either. Time and focus will allow you to recover from Chapter 7 bankruptcy quicker than you may think. There are a few basic concepts that, if embraced, will allow your credit to recover within two to four years.

Check your credit reports thirty days after your discharge. Ensure that debts included in your bankruptcy and discharged are correctly reported with zero balances. If you reaffirmed a secured debt and are making payments, ensure that they are being accurately reported. Dispute any inaccuracies promptly.
Pay all bills and debt that survived the bankruptcy timely. Consistent timely payments are the most effective way to improve your credit score. For debts that survived the bankruptcy and are not on a payment plan, reach out and get them on a payment plan immediately.
Create a proper budget. To avoid falling back into the debt trap, an honest and accurate budget is necessary. There are a whole host of budgeting apps available for free online.
Save an emergency fund. Consumer finance experts say that you should have six months’ expenses saved to cover an emergency. You won’t get there immediately, but saving even a small amount from each paycheck will get you there over time and keep you from relying on incurring credit for emergencies.
Get a secured credit card or credit rebuild loan. While it sounds counterintuitive, getting a new line of credit that you use and pay monthly will help rebuild your credit over time.
Have patience. Even if you do everything right, it will take 2-4 years before your credit score recovers fully. You have hit the reset button on your finances, you need to be patient and let them recover over time.

Chapter 7 bankruptcy exists because life is unpredictable, bad things happen to good people and sometimes finances simply spin out of control. Federal law recognizes that giving people a second chance is better for society than keeping them trapped in an endless cycle of debt. Chapter 7 is built on the idea of providing the honest but unfortunate debtor a fresh start. If this situation applies to you, it is worth your while to consult with an experienced bankruptcy attorney to discuss your specific situation.