The purpose of chapter 7 is to discharge debts and give the debtor a "fresh start" by extinguishing the debtor's personal liability on those debts. A discharge in Chapter 7 is available to individuals, not business entities such as 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 if the court finds the debtor has the ability to pay a meaningful dividend to unsecured creditors in a chapter 13 case.
How Chapter 7 Works
A chapter 7 case begins by filing a petition with the bankruptcy court in the district where the individual lives or where the business debtor has its principal place of business or its principal assets. The debtor is required to file schedules of assets and liabilities, including current income and expenses, and a statement of financial affairs. A husband and wife may file a joint petition, or a spouse may file individually.
Filing a petition "automatically stays" most creditor actions against the debtor and the debtor's property. The stay arises by operation of law without any judicial action. But for only limited exceptions [such as collecting a domestic support obligation], creditors cannot initiate or continue lawsuits, repossessions, or wage garnishments while the stay is in effect.
Federal bankruptcy law allows individual [vs. business] debtors to retain certain assets by claiming that property as "exempt" under federal bankruptcy law or the laws of the debtor's state. Married couples may only claim one set of exemptions.
A bankruptcy trustee is appointed when the case is filed. The trustee's main duties are to examine and verify the accuracy of the debtor's bankruptcy papers and to identify assets which are not exempt. The trustee may sell the non-exempt assets which have value and distribute the net proceeds to the creditors. If an asset has a loan against it, the debtor can usually keep the asset if the equity is exempt.
A "meeting of creditors" is held about 30 days after the petition is filed. The trustee runs the meeting, and the debtor must provide certain documents to the trustee in advance. The debtor must attend the meeting, and if a husband and wife file jointly, both must attend. Creditors may ask limited questions about the debtor's property, but creditors rarely come to the meeting.
The bankruptcy clerk issues the discharge, usually as soon as 60 days have elapsed from the first date set for the creditors meeting. A copy of the discharge is mailed to the debtor and all the creditors listed in the debtor's bankruptcy papers.
Role of the Trustee
A case trustee is appointed to conduct the creditor meeting and liquidate non-exempt assets. In the most cases, all of the debtor's assets are exempt or subject to valid liens, so the trustee usually has no assets to sell. If the debtor has non-exempt assets, or if the trustee later recovers assets to liquidate, the creditors are given a deadline to file a claim form stating the basis of their debt against the debtor or the debtor's assets.
The filing of a bankruptcy petition creates an "estate," and the trustee becomes the temporary legal owner of the debtor's property. The estate consists of all the debtor's legal or equitable interest 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.
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. As a general rule, individual debtors receive a discharge in most all chapter 7 cases.
A creditor has two options to oppose the discharge: 1) file a complaint objecting to the debtor's bankruptcy discharge; or 2) file a complaint to determine if the creditor's debt is excepted from the discharge. A creditor may pursue one or both of these remedies by filing a complaint with the bankruptcy court.
The grounds for objecting to a chapter 7 discharge are narrow, and the creditor or trustee objecting to the discharge has the burden of proving the case. In general, the grounds for denying a discharge are:
- the debtor failed to keep and produce adequate financial records;
- the debtor failed to explain satisfactorily a loss of assets;
- the debtor committed a bankruptcy crime;
- the debtor failed to obey a lawful order of the bankruptcy court; or
- the debtor fraudulently transferred, concealed, or destroyed property.
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, debts for death or personal injury caused by the debtor's operation of a boat or 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.
Debts for money or property obtained by false pretenses, debts for fraud while acting in a fiduciary capacity, or debts for willful and malicious injury to another or to the property of another will be discharged unless the creditor timely files an adversary complaint. The creditor must file the complaint within 60 days from the first date of the creditors meeting. In such cases the presumption is in favor of the discharge, and the creditor normally has the burden of proof to show the debt should be excepted from the bankruptcy discharge.
Secured creditors normally retain the right to seize their collateral 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 the 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 will still be owed after 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.
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 $18,000 but the car is only worth $10,000, it may be sensible to redeem the car for its market value. However, most debtors who file bankruptcy do not have ready cash [or a rich relative] to pay the 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.