What Is Chapter 7?

Bankruptcy is a serious business, so you need to understand it clearly. Chapter 7 of Title 11 in the U.S. bankruptcy code controls the process of asset liquidation. A bankruptcy 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 “straight” or “liquidation” bankruptcy.

Key Takeaways

  • Chapter 7 bankruptcy allows liquidation of assets to pay creditors.
  • Unsecured priority debt is paid first in a Chapter 7, after which comes secured debt and then nonpriority unsecured debt.
  • Filing Chapter 7 typically involves completing forms and a review of assets by the trustee.

Understanding Chapter 7 Bankruptcy

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. Secured debts are paid next. 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.

The bankruptcy process consists of the following steps:

Counseling and Forms

Filers must first undergo credit counseling within six months of filing before they begin the Chapter 7 bankruptcy process. If there is no 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 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 that prevents creditors from collecting on their debt. The stay also halts and prevents income garnishments. 

Trustee Appointment and Meeting of Creditors

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

Debt Repayment

The bankruptcy trustee reviews the personal assets and finances of the debtor. Exempt property—or property necessary to maintain basic standards of living—is retained by the debtor. Nonexempt 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, personal possessions, and car. The trustee then oversees the liquidation of all other property.

The Coronavirus Aid, Relief, and Economic Security (CARES) Act, signed into law by the president on March 27, 2020, excludes coronavirus-related relief aid from the calculation of a debtor’s current monthly income for the period of one year for pending bankruptcy cases.

Discharge of Remaining Debt

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 Code lists 19 categories of debts that are not dischargeable. In most instances filers receive a discharge approximately two months after the meeting of creditors.

Serious Ramifications

There are definitely negative consequences to bankruptcy, which is why debtors should be sure it is right for them. Creditors may attempt to recover debt after discharge, even though they have no right to it (so it’s important to retain bankruptcy documents, as duplicates can be costly). The instance of bankruptcy will appear on credit reports for 10 years from the filing date, seriously damaging the debtor’s ability to get loans. Also, a person cannot file and receive a subsequent Chapter 7 discharge within eight years of a previous Chapter 7 discharge. It's important to be especially prudent financially after going through Chapter 7.