Chapter 7 of the Title 11 of the United States Code governs the process of liquidation under
the bankruptcy laws of the United States.
Chapter 7 is the most common form of bankruptcy in the United States.
For businesses When a troubled business is badly in debt
and unable to service that debt or pay its creditors, it may file for bankruptcy in a
federal court under Chapter 7.
A Chapter 7 filing means that the business ceases operations unless continued by the
Chapter 7 Trustee.
A Chapter 7 trustee is appointed almost immediately, with broad powers to examine the business's
financial affairs.
The Trustee generally liquidates all the assets and distributes the proceeds to the creditors.
This may or may not mean that all employees will lose their jobs.
When a very large company enters Chapter 7 bankruptcy, entire divisions of the company
may be sold intact to other companies during the liquidation.
The investors who take the least risk are paid first.
For example, secured creditors take less risk because the credit that they extend is usually
backed by collateral, such as a mortgage or other assets of the company.
They know they will get paid first if the company declares bankruptcy.
Fully secured creditors, such as collateralized bondholders or mortgage lenders, have a legally
enforceable right to the collateral securing their loans or to the equivalent value, a
right which cannot be defeated by bankruptcy.
A creditor is fully secured if the value of the collateral for its loan to the debtor
equals or exceeds the amount of the debt.
For this reason, however, fully secured creditors are not entitled to participate in any distribution
of liquidated assets that the bankruptcy trustee might make.
In a Chapter 7 case, a corporation or partnership does not receive a bankruptcy discharge—instead,
the entity is dissolved.
Only an individual can receive a Chapter 7 discharge(1)).
Once all assets of the corporate or partnership debtor have been fully administered, the case
is closed.
The debts of the corporation or partnership theoretically continue to exist until applicable
statutory periods of limitations expire.
For individuals Individuals who reside, have a place of business,
or own property in the United States may file for bankruptcy in a federal court under Chapter
7.
Chapter 7, as with other bankruptcy chapters, is not available to individuals who have had
bankruptcy cases dismissed within the prior 180 days under specified circumstances.
In a Chapter 7 bankruptcy, the individual is allowed to keep certain exempt property.
Most liens, however, survive.
The value of property that can be claimed as exempt varies from state to state.
Other assets, if any, are sold by the interim trustee to repay creditors.
Many types of unsecured debt are legally discharged by the bankruptcy proceeding, but there are
various types of debt that are not discharged in a Chapter 7.
Common exceptions to discharge include child support, income taxes less than 3 years old
and property taxes, student loans, and fines and restitution imposed by a court for any
crimes committed by the debtor.
Spousal support is likewise not covered by a bankruptcy filing nor are property settlements
through divorce.
Despite their potential non-dischargeability, all debts must be listed on bankruptcy schedules.
A chapter 7 bankruptcy stays on an individual's credit report for 10 years from the date of
filing the chapter 7 petition.
This contrasts with a chapter 13 bankruptcy, which stays on an individual's credit report
for 7 years from the date of filing the chapter 13 petition.
This may make credit less available and/or terms less favorable, although high debt can
have the same effect.
That must be balanced against the removal of actual debt from the filer's record by
the bankruptcy, which tends to improve creditworthiness.
Consumer credit and creditworthiness is a complex subject, however.
Future ability to obtain credit is dependent on multiple factors and difficult to predict.
Another aspect to consider is whether the debtor can avoid a challenge by the United
States Trustee to his or her Chapter 7 filing as abusive.
One factor in considering whether the U.S. Trustee can prevail in a challenge to the
debtor's Chapter 7 filing is whether the debtor can otherwise afford to repay some or all
of his debts out of disposable income in the five year time frame provided by Chapter 13.
If so, then the U.S. Trustee may succeed in preventing the debtor from receiving a discharge
under Chapter 7, effectively forcing the debtor into Chapter 13.
It is widely held amongst bankruptcy practitioners that the U.S. Trustee has become much more
aggressive in recent times in pursuing abusive Chapter 7 filings.
Through these activities the U.S. Trustee has achieved a regulatory system that Congress
and most creditor-friendly commentors have consistently espoused, i.e., a formal means
test for Chapter 7.
The Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 has clarified this
area of concern by making changes to the U.S. Bankruptcy Code that include, along with many
other reforms, language imposing a means test for Chapter 7 cases.
Creditworthiness and the likelihood of receiving a Chapter 7 discharge are only a few of many
issues to be considered in determining whether to file bankruptcy.
The importance of the effects of bankruptcy on creditworthiness is sometimes overemphasized
because by the time most debtors are ready to file for bankruptcy their credit score
is already ruined.
Also, new credit extended post-petition is not covered by the discharge, so creditors
may offer new credit to the newly-bankrupt.
Methods of filing for bankruptcy Federal bankruptcy forms
Functionally, templates are more or less the computer based equivalent of paper bankruptcy
forms.
The official Federal bankruptcy forms prescribed in the Federal Bankruptcy Rules come as Microsoft
Word and Adobe Acrobat formatted templates where each bankruptcy form is represented
by a Word or Acrobat file.
While these forms are electronic in nature and reside on a computer, they do not contain
intelligence that would guide the debtor.
The debtor still has to fill in each bankruptcy form separately as they would with paper forms
and the debtor still has to grapple with the complexity of bankruptcy law.
Bankruptcy software In bankruptcy software, the debtor interacts
with the software through a web page and is shielded from the actual bankruptcy forms
and from the intricacies of bankruptcy law.
The debtor responds to questions in an interview setting, much like with tax programs such
as TurboTax or automated documents made through HotDocs.
The debtor enters names and addresses, a list of their creditors and assets and other financial
information and the software generates all the court-ready forms and delivers them to
the debtor via email or a download link.
The accuracy of the forms is nevertheless imperfect, as it is difficult for software
to ensure that the debtor understands what has to be disclosed, what the exemptions for
their state are, whether they qualify for said exemptions, and whether expenses included
on the means test are allowable.
Non-attorney petition preparer An alternative to do-it-yourself is the bankruptcy
petition preparer.
This method appeals to those who cannot afford the higher cost of bankruptcy attorneys and
at the same time do not want the hassle and uncertainty of self-prepared document templates
and software.
Bankruptcy petition preparers fill this need.
The bankruptcy forms are prepared by trained individuals rather than by debtor themselves.
However, having a preparer or paralegal prepare the petition does not guarantee compliance
with all applicable laws, or assure that maximum advantage will be taken of exemptions.
As with online bankruptcy software, debtors in some cases submit their bankruptcy information
through a simple web page interface.
Rather than having some software automatically generate the forms, trained paralegals use
the information to prepare the document and then deliver them to the debtor.
Bankruptcy trustees will check the bankruptcy petition to ensure that the petition was prepared
properly, much like the trustee would do if a lawyer had prepared the forms.
The BAPCPA provides guidelines for petition preparers to follow to protect the consumer.
Bankruptcy attorney A bankruptcy attorney can advise the consumer
on when the best time to file is, whether they qualify for a chapter 7 or need to file
a chapter 13, ensure that all requirements are fulfilled so that the bankruptcy will
go smoothly, and whether the debtor's assets will be safe if they file.
With expanded requirements of the BAPCPA bankruptcy act of 2005, filing a personal chapter 7 bankruptcy
is complicated.
Many attorneys that used to practice bankruptcy in addition to their other fields, have stopped
doing so due to the additional requirements, liability and work involved.
After the petition is filed, the attorney can provide other services.
2005 Bankruptcy Law Revision: the BAPCPA
On October 17, 2005 the Bankruptcy Abuse Prevention and Consumer Protection Act went into effect.
This legislation was the biggest reform to the bankruptcy laws since 1978.
The legislation was enacted after years of lobbying efforts by banks and lending institutions
and was intended to prevent abuses of the bankruptcy laws.
The changes to Chapter 7 were extensive.
Means test The most noteworthy change brought by the
2005 BAPCPA amendments occurred within.
The amendments effectively subject most debtors who have an income, as calculated by the Code,
above the debtor's state census median income to a 60 month disposable income based test.
This test is referred to as the "means test".
The means test provides for a finding of abuse if the debtor's disposable monthly income
is higher than a specified floor amount or portion of their debts.
If a presumption of abuse is found under the means test, it may only be rebutted in the
case of "special circumstances."
Debtors whose income is below the state's median income are not subject to the means
test.
Under this test, any debtor with more than $182.50 in monthly disposable income, under
the formula, would face a presumption of abuse.
Notably, the Code calculated income is based on the prior six months and may be higher
or lower than the debtor's actual current income at the time of filing for bankruptcy.
This has led some commentators to refer to the bankruptcy code’s “current monthly
income” as “presumed income.”
If the debtor's debt is not primarily consumer debt, then the means test is inapplicable.
The inapplicability to non-consumer debt allows business debtors to "abuse" credit without
repercussion unless the court finds "cause."
"Special circumstances" does not confer judicial discretion; rather, it gives a debtor an opportunity
to adjust income by documenting additional expenses or loss of income in situations caused
by a medical condition or being called or order to active military service.
However, the assumption of abuse is only rebutted where the additional expenses or adjustments
for loss of income are significant enough to change the outcome of the means test.
Otherwise, abuse is still presumed despite the "special circumstances."
Credit counseling Another major change to the law enacted by
BAPCPA deals with eligibility. §109(h) provides that a debtor will no longer be eligible to
file under either chapter 7 or chapter 13 unless within 180 days prior to filing the
debtor received an “individual or group briefing” from a nonprofit budget and credit
counseling agency approved by the United States trustee or bankruptcy administrator
The new legislation also requires that all individual debtors in either chapter 7 or
chapter 13 complete an “instructional course concerning personal financial management.”
If a chapter 7 debtor does not complete the course, this constitutes grounds for denial
of discharge pursuant to new §727(a)(11).
The financial management program is experimental and the effectiveness of the program is to
be studied for 18 months.
Theoretically, if the educational courses prove to be ineffective, the requirement may
disappear.
Applicability of exemptions BAPCPA attempted to eliminate the perceived
“forum shopping” by changing the rules on claiming exemptions.
Under BAPCPA, a debtor who has moved from one state to another within two years of filing
the bankruptcy case must use exemptions from the place of the debtor’s domicile for the
majority of the 180 day time period preceding the two years before the filing §522(b)(3).
If the new residency requirement would render the debtor ineligible for any exemption, then
the debtor can choose the federal exemptions.
BAPCPA also “capped” the amount of a homestead exemption that a debtor can claim in bankruptcy,
despite state exemption statutes.
Also, there is a “cap” placed upon the homestead exemption in situations where the
debtor, within 1215 days preceding the bankruptcy case added value to a homestead.
The provision provides that “any value in excess of $125,000” added to a homestead
can not be exempted.
The only exception is if the value was transferred from another homestead within the same state
or if the homestead is the principal residence of a family farmer).
This “cap” would apply in situations where a debtor has purchased a new homestead in
a different state, or where the debtor has increased the value to his/her homestead.
Lien avoidance Some types of liens may be avoided through
a chapter 7 bankruptcy case.
However, BAPCPA limited the ability of debtors to avoid liens through bankruptcy.
The definition of “household goods” was changed limiting “electronic equipment”
to one radio, one television, one VCR, and one personal computer with related equipment.
The definition now excludes works of art not created by the debtor or a relative of the
debtor, jewelry worth more than $500, and motor vehicles(1)(B)).
Prior to BAPCPA, the definition of household goods was broader so that more items could
have been included, including more than one television, VCR, radio, etc.
Other changes Decreased the number and type of debts that
could be discharged in bankruptcy.
Decreased limits for discharge of debts incurred discharging luxury goods.
Expanded the scope of student loans not dischargeable without undue hardship.
Increase the time in which a debtor may have multiple discharges from 6 to 8 years.
Limited the duration of the automatic stay, particularly for debtors who had filed within
one year of a previous bankruptcy.
Automatic stay may be extended at the discretion of the court.
BAPCPA limited the applicability of the automatic stay in eviction proceedings.
If the landlord has already obtained a judgment of possession prior to the bankruptcy case
being filed, a Debtor must deposit an escrow for rent with the Bankruptcy Court, and the
stay may be lifted if the Debtor does not pay the Landlord in full within 30 days thereafter,
§362(b)(22).
The stay also would not apply in a situation where the eviction is based on “endangerment”
of the rented property or “illegal use of controlled substances” on the property,
§362(b)(23).
BAPCPA enacts a provision that protects creditors from monetary penalties for violating the
stay if the debtor did not give “effective” notice pursuant to [§342(g)].
The new notice provisions require the debtor to give notice of the bankruptcy to the creditor
at an “address filed by the creditor with the court,” or “at an address stated in
two communications from the creditor to the debtor within 90 days of the filing of the
bankruptcy case.
References
External links Wiki Law Database - Chapter 7