What is 'Chapter 7'

Chapter 7 of Title 11 in the U.S. bankruptcy code controls the process of asset liquidation. A trustee is appointed to liquidate nonexempt assets to pay creditors; after the proceeds are exhausted, the remaining debt is discharged. There are eligibility requirements to file Chapter 7, such as the debtor must have had no Chapter 7 bankruptcy discharged in the preceding eight years and the applicant must pass a means test.

This process is also known as a straight or liquidation bankruptcy.

BREAKING DOWN 'Chapter 7'

In Chapter 7 bankruptcy, the absolute priority rule stipulates the order in which debts are to be paid.  Under this rule, unsecured debt is separated into classes or categories with each class receiving priority for payment. Secured debt is debt backed or secured by collateral to reduce the risk associated with lending, such as a mortgage.

Unsecured priority debts are paid first. Examples of unsecured priority debts are tax debts, child support, and personal injury claims against the debtor. Next, secured debts are paid. Last is the payment of nonpriority, unsecured debt with funds remaining from the liquidation of assets.  If there are not sufficient funds to pay the nonpriority unsecured debt, then the debts are paid on a pro-rata basis.

Chapter 7 Process

A filer must first undergo credit counseling within six months of filing before they begin the Chapter 7 bankruptcy process. If there is not an approved counseling agency in the district, they may forgo this step. Other exceptions may apply depending on the debtor's circumstances.

The applicant must complete several forms, including a petition to the court, to begin the official Chapter 7 proceedings. The series of forms detail personal information, such as the debtor's finances, creditors, assets, income, and expenses. After filing the petition, an automatic stay is in effect preventing creditors from collecting on their debt. The stay also halts and prevents income garnishments

The bankruptcy court will appoint an unbiased trustee to oversee the entire bankruptcy process. The trustee will review assets and determine which assets can be liquidated to pay creditors. The trustee schedules meetings with the creditors, where they confirm the validity of the petition and finances. As the name suggests, the meeting of the creditors allows creditors to meet with the trustee and the debtor to ask questions. 

The bankruptcy trustee reviews the personal assets and finances of the debtor. Exempt property, or property necessary to maintain basic standards of living, are retained by the debtor. Non-exempt property is seized and liquidated to pay creditors. Property exemptions vary in each state. However, in many cases, debtors are allowed to keep their primary home, their car, and personal possessions. The trustee then oversees the liquidation of all other property.

The bankruptcy court then determines Chapter 7 eligibility. The court will allocate resources to pay debts and oversee the discharge, or release, of the bankruptcy. Before the discharge, the debtor must satisfactorily complete a financial management course.

Chapter 7 Discharge of Debts

Most debts are discharged under a Chapter 7 bankruptcy. The discharge of debt will release the debtor from any personal liability for payment. Once a deficit is discharged under Chapter 7, the creditor may no longer seek future restitution from the creditor. Obligations relating to alimony, child support, some government debts, income taxes, and federal student loans are not allowable for release during bankruptcy. The law is very restrictive on discharging money owed for income taxes and student loans. The United States Bankruptcy Court lists 21 categories of non-dischargeable debts.

In most instances, filers receive a discharge approximately two months after the meeting of the creditors. The debtor should retain bankruptcy documents, as duplicates can be costly, and creditors may attempt to recover debt after discharge. The instance of bankruptcy will appear on credit reports for ten years from the filing date.  A person cannot file and receive a subsequent Chapter 7 discharge within eight years of a previous Chapter 7 discharge.

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