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Chapter 7 Bankruptcy

What is Chapter 7 Bankruptcy?

Chapter 7 bankruptcy is referred to as liquidation and is typically used when the business' debt is overwhelming and it is unlikely that that it will be able to return to profitability. When the petition is filed, an automatic stay goes into which stops collection activities by creditors. A trustee is appointed who is responsible for selling the small business debtor's assets to pay off the creditors.

Small business owners who are struggling with a lot of debt may find relief through Chapter 7 bankruptcy. This is because this specific chapter can eliminate most or all of the debts that they are liable for. Sole proprietors, or businesses considered to be a general partnership, are personally liable for the business's debts. They may also be able to file a Chapter 7 in order to eliminate most or all of their debt. Otherwise, they will need to consider filing for a Chapter 11 bankruptcy.

For a sole proprietor, a Chapter 7 personal bankruptcy can discharge both personal and business debts. If a partnership files a Chapter 7, the business will be liquidated and the assets will be sold; however, any partner that is personally liable for any of the business debt may also need to file for personal bankruptcy. If the business is set up as a Limited Liability Company or Corporation, the debts cannot be discharged, the assets will be sold and the business will cease operating. There are a number of factors involved in deciding whether a small business should file for bankruptcy, including the type and amount of debt involved, whether or not it wants to continue operating, as well as its prospects for regaining profitability.

Chapter 7 bankruptcy permits an individual to discharge all of their debts which can legally be discharged. It is important to note that each state has their own income requirements, which may vary. If the individual's income exceeds the cut off, the court will apply a means test which is based on their previous 6 months of income. If the individual is found to have the means, or the income, to repay their debts, they will not be eligible to file for Chapter 7 bankruptcy.

It is important to note that not all debts are eligible or will be discharged in a bankruptcy. Those debts which are non-dischargeable include:

  • Child support payments
  • Child support back debts;
  • Spousal support;
  • Debts associated with DUI charges or convictions;
  • Criminal fines;
  • Debts which are not included in the Chapter 7 filing petition;
  • Tax debt, although some federal tax debt may be discharged if certain criteria are met;
  • Debts created through fraud; and
  • Student loans, although the court may determine undue hardship exists and the debt may be discharged.

It is important to note, however, that bankruptcy may have lasting consequences for the debtor and may remain on their credit report for up to 10 years. It may prevent them from obtaining credit cards and loans, therefore, they should consider all other available options first.

How Does Chapter 7 Bankruptcy Work?

After the individual filing for bankruptcy, called the debtor, files their Chapter 7 bankruptcy petition, the court will issue an automatic stay. This prevents creditors from attempting to collect on debts. It also prevents:

  • Pending lawsuits;
  • Wage garnishments;
  • Filing of liens; and
  • Seizure of property.

In a Chapter 7 bankruptcy, the majority of the debtor's property is seized and often sold. The court appoints a bankruptcy trustee to oversee each individual bankruptcy case. The trustee determines whether selling the debtor's property will generate enough income or profit to pay off creditors.

After the debtor completes and files all required paperwork, the trustee schedules the 341 creditors meeting. The debtor is required to appear at this meeting and failure to do so or failure to provide the requested information may result in the dismissal of the bankruptcy case.

Following the creditors meeting, the bankruptcy court will hold a discharge meeting to discharge the eligible debts. At this meeting, the debtor's unsecured debt will be discharged.

Other types of debt, such as mortgages or car loans may receive different treatment. At the beginning of bankruptcy proceedings, the debtor may choose from one of the following options to handle certain debts:

  • Pay the creditor the replacement value of the property or item;
  • Return the property, or;
  • Reaffirm the old payment terms or agree to new payment terms with the creditor.

What are Exempt and Non-Exempt Properties?

In a Chapter 7 bankruptcy, there is certain property which is exempt from liquidation. The debtor may be required to forfeit some of their property which is non-exempt to be sold in order to satisfy their creditors.

Examples of exempt property include:

  • Vehicles up to a certain value;
  • Jewelry up to a certain value;
  • Necessities such as clothing, furniture, and household appliances;
  • Tools of the individual's trade, up to a certain value;
  • Certain unpaid earned wages;
  • Pensions; and
  • Some public benefits which include welfare, unemployment and social security, if held in a bank account.

Examples of non-exempt property include:

  • A second vehicle or other motor vehicles;
  • A second home or vacation property;
  • Some valuables such as antiques or coin collections;
  • Certain funds in bank accounts;
  • Cash; and
  • Some securities like stocks or bonds.

It is important to note that the exempt property and property values will vary by state. It is also important to be aware that some states require an individual to use the state exemptions while others allow the debtor to choose between federal and state exemptions.

How Long Does Chapter 7 Bankruptcy Process Take?

The length of a Chapter 7 bankruptcy case will vary based on the debtor and their individual case, especially if that case is complex. In most cases, the entire bankruptcy process takes between 4 to 6 months. The process can be expedited by having the assistance of an attorney and the prompt and complete providing of any required or requested documentation.

Who Qualifies for Chapter 7 Bankruptcy?

Only debtors who meet certain income criteria will be eligible to file for Chapter 7 bankruptcy. In order to qualify, the petitioner's income must be equal to or fall below the median income in their state. This is known as the “bankruptcy means test.” Median incomes used in the means test can vary widely from state to state. Thus, it is important to check the income requirements of a particular state.

If the petitioner's income is above the median income requirement in their state, then a second test will be conducted that measures their income against their monthly essential expenses (e.g., groceries, medications, etc.). 

The court will use the results of the means test and/or the essential expenses test to determine whether the petitioner qualifies for Chapter 7 bankruptcy. Those who fail to qualify for Chapter 7 bankruptcy, may still be eligible to file for Chapter 13 bankruptcy.

Aside from the income requirements, a petitioner filing for Chapter 7 bankruptcy must also have first attended credit counseling before filing, must not have attempted to defraud creditors or the court, must not have had a debt discharged under Chapter 7 bankruptcy within the past eight years, and must fulfill a few other conditions.

Although filing for bankruptcy should generally be avoided, filing for Chapter 7 bankruptcy provides better benefits to debtors than those who file for Chapter 13 bankruptcy. For instance, a debtor who successfully satisfies the requirements of a Chapter 7 bankruptcy filing can have their debts completely discharged via a court order. 

On the other hand, a debtor who files for Chapter 13 bankruptcy, must repay their creditors in accordance with a three to five year plan.

Additionally, unlike debtors who file for Chapter 13 bankruptcy, those who file for Chapter 7 bankruptcy can receive immediate and permanent relief, will most likely get to keep the majority of their property, and they will not need to make a repayment plan since creditors will no longer be able to collect on the debt. 

This also means that the debtor will be allowed to keep their future income, instead of having to pay it back as part of their Chapter 13 repayment plan. 

What is the Difference Between Chapter 7 vs Chapter 13 Bankruptcy?

There are several differences between a Chapter 7 bankruptcy and a Chapter 13, which is also known as a wage earner's bankruptcy. As noted above, a Chapter 7 bankruptcy involves liquidation of the debtor's property and discharge of their debts.

A Chapter 13 bankruptcy, on the other hand, allows the debtor to keep their property and repay their creditors using a payment plan and restructuring their finances. Chapter 13 bankruptcy is often used by individuals with higher incomes.

A Chapter 13 bankruptcy is typically more favorable for the debtor's credit ratings. A Chapter 7, however, may be more helpful to a debtor in relieving their financial burdens. Certain debts may be eligible for discharge but other debts may require payment using the payment plan, which typically lasts between 3 and 5 years.

How to File for Chapter 7 Bankruptcy

The first thing that an individual should do when filing for Chapter 7 bankruptcy is to compile their financial records and make a list of all their debts, assets, income, property, liabilities, and expenses. They should also review what types of property are exempt from bankruptcy in their state and which kinds of debt are not dischargeable in a bankruptcy proceeding. 

Once this is complete, federal bankruptcy law requires that a debtor attend credit counseling sessions within 180 days before filing for bankruptcy. At the end of counseling, the debtor should receive a certificate of completion that proves they completed this requirement. If a debtor fails to obtain this certificate, then the court will reject their bankruptcy filing outright.

After credit counseling is complete, the debtor may file a bankruptcy petition with a federal bankruptcy court. If the court grants the petition, the case will then be assigned to a court trustee who will schedule a meeting of the creditors. The debtor must attend this meeting and answer any questions that the trustee has about the case. The debtor will also have to attend a second debtor education course before a decision is made. 

When all of the above steps are finished, the court will determine whether or not to issue a discharge order. Debtors who receive a discharge order will be protected against future collections and will no longer be obligated to pay their pending debts. 

How to File for Chapter 7 Bankruptcy Online

Filing bankruptcy Chapter 7 online is not generally recommended. Bankruptcy filings involve a lot of strict requirements, procedures, and confusing laws. The average cost of filing for Chapter 7 bankruptcy is $335. If a mistake is made in the process, the cost of reopening a case will be an additional $260 or more depending on if a lawyer is needed. 

The steps to file for Chapter 7 bankruptcy online are mostly the same as what is required of those who choose to use a lawyer to file or file in person with the court. This means that the individual must understand how to take the means test, evaluate their finances and assets, and be sure that Chapter 7 is the appropriate Chapter of Bankruptcy to file. 

Additionally, not every state allows individuals to file for Chapter 7 bankruptcy without a lawyer. Thus, a debtor must check state laws to see if this service is even offered in their state.

Automatic Stay

Once a debtor files a petition for Chapter 7 bankruptcy, a federal bankruptcy court will immediately issue an “automatic stay.” An automatic stay is an injunction that prevents creditors from collecting or suing a debtor over debts owed. The injunction does not discharge a debt, however, it only suspends proceedings to collect or sue on the debt until the stay is lifted or the bankruptcy case is closed. 

In addition, it also prohibits the creditor from sending collection letters, calling a debtor, garnishing wages from a debtor's paychecks, repossessing property, foreclosing on a debtor's home, or any other activities typically associated with debt collections. The automatic stay order will remain in place until a final decision is made.

The Appointment of a Trustee

In general, a trustee is typically defined as a person who has a legal obligation to oversee or distribute certain properties under specific circumstances. Thus, it stands that in a Chapter 7 bankruptcy proceeding, an appointed trustee is an individual who manages the assets and/or property of the debtor while they are continuing to pay off any debts still owed to their creditors. 

In addition, a trustee in a Chapter 7 bankruptcy case may also be responsible for reviewing the bankruptcy petition and supplemental filing claims, monitoring transfers and security interests, and converting assets into cash (i.e., liquidation), which is then used to clear the petitioner's debts.

A trustee may be appointed either by the bankruptcy court hearing the case, or sometimes by the creditors. Chapter 7 trustees, also known as “panel trustees,” are chosen from a local panel that the U.S. Trustee assigns to each district. Although the court ultimately appoints a trustee during a bankruptcy proceeding, they are usually assigned through a blind rotation process. 

 Debtors, but not necessarily the creditors, must meet with the trustee assigned to their case at the “meeting of the creditors,” which is sometimes informally referred to as a “341 meeting” due to the section it falls under in the U.S. Bankruptcy Code. During the 341 meeting, the creditors will decide if they want to elect a permanent trustee or if the court-appointed interim trustee will become the permanent trustee for the remainder of the case. 

If the creditors decide to elect a new person to become the permanent trustee, they must do so at the 341 meeting. However, only certain types of creditors are allowed to request a new trustee. In order to be eligible to appoint a new trustee, the creditor must hold at least twenty percent of the amount owed by the debtor, the amount must be specific and undisputed, the debt must not be tied to any property (i.e., unsecured debt), and the creditor must not be considered an insider.

Finally, in situations where the creditor does not wish to appoint a new trustee or if the creditor is not eligible to vote for one, then the interim trustee assigned by the court will oversee the liquidation of assets and distribute payments to the creditors until all debts are satisfied and the matter is discharged.

What is the Coronavirus Aid, Relief, and Economic Security Act (“CARES Act”)?

The Coronavirus Aid, Relief, and Economic Security (CARES) Act is a federal economic stimulus bill that was passed by former President Trump in 2020 in response to the COVID-19 pandemic. This Act provided economic aid to individuals affected by the pandemic.

The Act provided tax rebate payments to Americans and additional payments to parents with minor children. The Act also provided extensions and funding for many different issues related to the COVID-19 pandemic. This includes Chapter 7 bankruptcy filings.

How Does the CARES Act Affect Chapter 7 Bankruptcy Filings?

The CARES Act provided some temporary and short-term relief to debtors that filed for Chapter 7 bankruptcy. The CARES act does not require individuals to count their COVID-19 related economic stimulus payments as income as it relates to their Chapter 7 bankruptcy.

The CARES Act has amended the Small Business Reorganization Act of 2019 (SBRA) and expanded protections that are provided for small business owners who are filing for bankruptcy. Originally, a small business could choose between a Chapter 7 or Chapter 11 bankruptcy.

Now, if the small business owner has less than $7,500,000 in debt, they may operate as a small business debtor. This is a hybrid of Chapter 7 and Chapter 11.

A trustee is appointed to oversee the reorganization and the process is more streamlined than a typical Chapter 11. In addition, it is more difficult for a creditor to contest the plan.

The goal of this amendment is to assist small business owners who are affected by COVID-19 and save jobs. It is important to be aware that the SBRA had a deadline for filing in 2021, but may be extended. Consult with an attorney to determine if this option is still available today.

The Discharge of Debt under Chapter 7 Bankruptcy

In a Chapter 7 bankruptcy filing, a “discharge of debt” refers to when the bankruptcy court issues an order that relieves the debtor from having to pay off their creditors and prohibits the creditors from collecting on any debts owed to them. Though creditors are allowed to repossess property and enforce any liens attached to secured debts, they may not sue or badger a debtor over any debts that are discharged.

While this may sound like a relief, receiving a discharge order can impact a debtor's credit report for up to 10 years. Also, not all debts are dischargeable and not every debtor may request to have their debt discharged. Only debtors who qualify and satisfy all court requirements will be eligible to have their debt discharged. 

Some items that are not considered dischargeable debt include federal student loans, alimony, child support, criminal fines or restitution, property and business taxes that were due prior to the filing, court costs, and retirement plan loans. This is not an exhaustive list of the items that may not be discharged in a Chapter 7 bankruptcy filing. Thus, it may be wise to consult a local bankruptcy lawyer for more information regarding dischargeable debts. 

Changes to Chapter 7 Bankruptcy Law

As a response to the pandemic, Congress passed the Coronavirus Aid, Relief, and Economic Security Act (“CARES Act”) in March 2020. Although the primary purpose of this Act is to provide emergency assistance and healthcare to those affected by the pandemic, it also made some significant changes to the provisions of various federal bankruptcy laws.

Specifically, the CARES Act has amended the definition provided for “current monthly income” under Chapter 7 bankruptcy filings. The definition now permits individuals to exclude payments made to them pursuant to the CARES Act. In other words, if a debtor received payment due to a condition triggered in the CARES Act, they will not have to include the amount as part of their income.

This change is crucial when it comes to filing Chapter 7 bankruptcy because whatever amount they received as part of the CARES Act will not alter their means test calculation, which again, determines a debtor's eligibility for filing for Chapter 7 bankruptcy. Thus, an amount connected to the CARES Act that could have potentially put a debtor over the threshold requirement for Chapter 7, will no longer have this effect and the debtor will still be eligible.

It is important for debtors to remain aware of changes to the U.S. Bankruptcy Code, such as the one just discussed, because they can have a serious impact on the outcome of a bankruptcy filing. Instead of continuously reviewing the laws and trying to make sense of all the legal jargon, it may be much more helpful to hire a lawyer whose job it is to keep debtors informed. 

Chapter 7 bankruptcy lawyers not only need to stay abreast of new laws and amendments to the U.S. Bankruptcy Code, but they also can explain any changes made and increase the chances of filing a successful bankruptcy case.

Do I Need a Lawyer for Help with Chapter 7 Bankruptcy Issues?

Filing for bankruptcy is a serious matter that requires precise attention to detail. An individual will need to evaluate all of their income, expenses, property, and assets, as well as will have to follow a strict legal process. A person will also have to know any changes made to the law and how to apply them. 

Therefore, if you are considering filing for Chapter 7 bankruptcy, then you should contact a local bankruptcy lawyer for further guidance immediately.

An experienced bankruptcy lawyer will already be familiar with the U.S. Bankruptcy Code, can discuss what Chapter of bankruptcy you may be eligible for, and can help you prepare and file for the appropriate Chapter of bankruptcy. Your lawyer can also answer any questions or concerns you have throughout the process, as well as will be able to represent you at any bankruptcy proceedings.