The purpose of Chapter 7 is to discharge debts and give the debtor a “fresh start.” The discharge extinguishes the debtor’s personal liability on debts. A discharge is available to individuals, but not partnerships or corporations. Although most individual Chapter 7 cases result in a discharge of all debts, some types of debts are not discharged, and a discharge does not extinguish liens on property. In rare cases a Chapter 7 may be dismissed as an abusive filing if the court finds an individual has the ability to pay a meaningful dividend to unsecured creditors in a Chapter 13 case.
How Chapter 7 Works
Individual debtors who file a Chapter 7 are seeking to discharge their pre-petition debts. The debtors must list all of their assets and liabilities. One schedule filed by individual debtors lists “exempt” property. Federal bankruptcy law provides that an individual debtor can protect certain assets from creditor claims because this property is exempt under federal bankruptcy law or the laws of the debtor’s state. Married couples may only claim one set of exemptions.
Approximately 30 days after the petition is filed, the Chapter 7 trustee appointed to the case conducts the meeting of creditors. The trustee examines the debtor’s bankruptcy statements and schedules in an attempt to verify their accuracy and to identify non-exempt assets. The trustee sells the non-exempt assets which have value and distributes the net proceeds to the creditors. If an asset has a loan against it, the debtor can keep the asset if the equity is exempt. If there are no non-exempt assets, the case is identified as a “no asset case” and there are no distributions to creditors.
Generally speaking, creditors have sixty (60) days from the first date set for the creditor meeting within which to object to the debtor’s discharge. If no creditors object to the debtor’s discharge or seek to have their debt excepted from discharge, the Bankruptcy Court Clerk will issue the debtor a discharge. The discharge is usually issued a few days after the 60 day period has elapsed. A copy of the discharge is mailed to the debtor and to all of the creditors listed in the debtor’s schedules.
Role of the Chapter 7 Trustee
Once a Chapter 7 case is filed, a Chapter 7 trustee is appointed to administer the case and liquidate the debtor’s non-exempt assets. In most cases, all of the debtor’s assets are exempt or subject to valid liens, so a trustee usually has no assets to sell. These are called “no asset” cases. If the debtor has non-exempt assets or if the trustee later recovers assets to liquidate for distribution to unsecured creditors, the creditors are given an opportunity to file a form (“Proof of Claim”) stating the basis of their claim against the debtor or the debtor’s assets.
The filing of a bankruptcy petition creates an “estate,” and the trustee, as administrator of the estate, becomes the temporary legal owner of the debtor’s property. The estate consists of all the debtor’s legal or equitable interests in property, including property owned or held by another person. The estate includes tangible and intangible assets, such as insurance claims or lawsuits for damages.
The trustee can sell non-exempt property as well as property with a market value in excess of the sum of any security interest or lien and the allowed exemption the debtor holds in the property. Objections to debtor’s exemption claims must be filed within 30 days of the date a creditors meeting is completed.
Chapter 7 Discharge
A bankruptcy discharge releases the debtor from personal liability and prevents the creditors from taking any further action against the debtor or his property to collect the debts.
Once a discharge is granted, the trustee, a creditor, or the U.S. Trustee may later file a complaint to revoke a Chapter 7 discharge if they can prove: a) the discharge was obtained through the fraud of the debtor; or b) the debtor acquired property that is property of the estate and knowingly and fraudulently failed to report the acquisition of such property or to surrender the property to the trustee. Generally, this complaint must be filed within a year after the discharge was granted.
Certain types of debts may not be discharged in a Chapter 7 such as alimony and child support, most taxes, student loans made or guaranteed by a governmental unit, debts for death or personal injury caused by the debtor’s operation of a motor vehicle while intoxicated from alcohol or other substances, and debts for criminal restitution orders. To the extent that these types of debts are not fully paid in the Chapter 7 case, the debtor is still responsible for them after the bankruptcy.
Secured creditors normally retain the right to seize their loan collateral, even after a discharge is granted. The debtor must decide whether to keep the asset. If a debtor returns the collateral, and if a discharge is granted, the debtor will have no further liability to the creditor.
A debtor wishing to keep an asset, such as an automobile, may “reaffirm” the debt or redeem the property. A reaffirmation is an agreement between the debtor and the creditor where the debtor promises to pay all or a portion of the money owed. The reaffirmed debt survives the discharge. In return, the creditor promises as long as payments are made, the creditor will not repossess the automobile or other property. If the debtor defaults on the payments, the creditor may repossess and sell the collateral. Unfortunately, if the sale price is not enough to pay off the debt, the debtor will still owe a deficiency to the creditor.
Another option utilized by some debtors is to retain the asset and remain current on the loan which is secured by the asset. The creditor retains its right to seize the collateral and may do so if the debtor defaults on the payments. However, unlike a reaffirmed debt, the debtor will not owe a deficiency, because the debtor did not formally agree to reaffirm the debt.
A debtor may opt to redeem an asset by paying the fair market value in a lump sum. For example, if the balance on a car loan is $15,000 but the car is only worth $10,000, it may be sensible to redeem the car. The problem is most debtors who file bankruptcy do not have ready cash to pay the fair market value in one lump sum. There are companies who provide redemption financing. Their interest rates are high, but if the gap between the loan balance and the value of the car is large enough, a redemption loan may be less expensive than the existing loan on the car.