US Bankruptcy laws are intended to help individuals or corporations that, for one reason or another, have become unable to pay their creditors. Although the US federal Courts oversee bankruptcies occurring under a wide variety of conditions, the three most common forms of Bankruptcy are described in Chapter 7, Chapter 11, and Chapter 13 of the United States Bankruptcy Code. Chapters 11 and 13 are designed to serve individuals or businesses that are having trouble meeting current debt obligations, but seek an opportunity to reorganize or restructure debt so they can continue in operation, and hopefully pay back most or all of their incurred debts within a set time period.
What is Chapter 7 Bankruptcy for – and not for?
Chapter 7 Bankruptcy provides a rigorous but orderly framework for certain assets of the debtor to be liquidated by a Bankruptcy Trustee, with the liquidation proceeds, if any, distributed in lieu of total payment to creditors. Some types of assets are protected from liquidation by State Laws. The Court then issues a discharge order preventing further collection activities, especially by unsecured creditors. The successful Chapter 7 Bankruptcy petitioner gets to resume their life with a clean(er) slate (see note on secured loans below). Important points to remember about Chapter 7 Bankruptcy include:
- Chapter 7 Bankruptcy rules are not intended to protect individuals or partnerships that expect to continue in the same line of business after shedding the debt obligations they have incurred up to that point in time.
- Rules regarding the amounts and types of assets that are exempt from seizure and liquidation vary widely from state to state.
- Chapter 7 Bankruptcy laws now require that all petitioners must demonstrate that they have participated in an approved nonprofit budget and credit counseling program within the six months preceding the application.
- If part of the total debt is secured by collateral (as in the case of the mortgages and auto loans), Chapter 7 Bankruptcy does not prevent the creditor from foreclosing on the home or other assets pledged as security – unless the debtor has specifically agreed to remain legally liable for that loan.
- Chapter 7 Bankruptcy rules do not protect the debtor from court ordered child support obligations or from certain taxes.
- If a petition for debt relief under Chapter 7 is successful, the protection granted by the Court applies only to the applicant. It does not apply to persons who may have cosigned a loan with the petitioner, or to business partners who are not co-applicants for protection.
What is a Chapter 7 Bankruptcy Means Test?
To prevent fraudulent use of Chapter 7 Bankruptcy protection, complex formulas (involving the applicant’s income, basic living expenses, the median income for the state of residence, and the total amount of debt, etc.) are applied to determine whether or not a petitioner could satisfy pay off their debts by tightening their belt, or by restructuring payments under a different chapter of the Bankruptcy Code or a simple debt consolidation loan. If a Chapter 7 Bankruptcy applicant fails to qualify under the means test, they may be asked to switch their application to Chapter 13, or they may have their application simply dismissed.
What information must Be Provided to File for Chapter 7 Bankruptcy?
Filing for Chapter 7 Bankruptcy requires the completion of a Statement of
Financial Affairs and a number of additional Court provided forms. Taken together, the information that must be filed with a petition for Chapter 7 Bankruptcy protection will include at least the following:
- A description of the applicant’s financial history
- A description of the amounts and sources of the applicants income
- A list of so-called priority debts (child support and certain taxes)
- A list of the petitioner’s secured creditors, including their names, current contact information, and the amounts owed
- A list of the applicant’s unsecured creditors (such as credit card companies), including the correct names, contact information, and amounts owed for each creditor
- information regarding real estate holdings, including any properties that the applicant owns jointly with their spouse or any other person
- A comprehensive listing of all of the applicant’s personal property, including household goods, appliances, clothing, motorcycles, etc.
- A summary of all cash on hand, accrued net wages, and retirement funds.
The applicant must include those assets that they believe are (or should be) exempt from seizure and liquidation. Providing information that is incorrect, incomplete, or in any way misleading, may result in forfeiture of filing fees and the denial of the Chapter 7 Bankruptcy petition.
Bankruptcy Court Creditor Meetings
After payment of filing fees and provision of required information, the Bankruptcy Court will publicly announce the time and location of a meeting for all named creditors (and potentially others who consider themselves creditors). The applicant or applicants (i.e. spouses or business partners) petitioning for Chapter 7 Bankruptcy relief, will be placed under oath at the beginning of the meeting. The Court Trustee handling the case will first ask the petitioner(s) a series of questions to ensure that they understand the consequences of submitting untruthful information, providing untruthful answers during the current meeting, and the potential impacts on their credit score should they be successful in the Chapter 7 Bankruptcy petition.
The Trustee will then ask a series of questions regarding the information provided with the petition. If the Court Trustee determines that the information provided is unsubstantiated by the answers the petitioner(s) provide under oath, the Trustee may declare the petition presumptively fraudulent, and terminate the petition. Petitioners can appeal that decision. If the Court Trustee allows the Creditor Meeting to move forward, other creditors in attendance are given an opportunity to ask their own questions, or challenge the factual basis of assertions included in the petition.
Bankruptcy Court Options
Except in cases when the Creditor Meeting is extended for the collection of additional information or other purpose, the Bankruptcy Court responds in one of several ways within ten days. Possible responses include but are not limited to:
- Granting the requested discharge order and beginning the liquidation process
- Granting the requested discharge order, but excluding some named debts
- Dismissing the Chapter 7 Bankruptcy petition, and offering the petitioner(s) the opportunity to file a new petition under Chapter 13 of the Bankruptcy Code.