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How Does Chapter 7 Bankruptcy Work?

A Chapter 7 bankruptcy case begins with the debtor filing a petition with the bankruptcy court.

The petition is filed with the bankruptcy court serving the area where the individual lives or where the business debtor is organized or has its principal place of business or principal assets. A creditor holding claims against the debtor can file an involuntary Chapter 7 case against the debtor under certain circumstances.

In addition to filing the petition and related schedules, an individual debtor must also:

  • Complete a credit counseling course before filing
  • Complete a debtor education course during the bankruptcy
  • Provide the case trustee with all pay stubs received 60 days before the filing
  • Provide the case trustee with the most recent income tax return or transcript

Even if filing jointly, a husband and wife are subject to all the document filing requirements of individual debtors.

In order for the attorney to complete the forms that make up the petition, the statement of financial affairs, and the schedules, the debtor must provide the following information:

  1. A list of all creditors and the amount and nature of their claims;
  2. The source, amount, and frequency of the debtor’s income;
  3. A list of all of the debtor’s property; and
  4. A detailed list of the debtor’s monthly living expenses, i.e., food, clothing, shelter, utilities, taxes, transportation, medicine, etc.

Married individuals must gather this information for their spouse regardless of whether they are filing a joint petition, separate individual petitions, or even if only one spouse is filing.

In a situation where only one spouse files for bankruptcy, the income and expenses of the non-filing spouse are required so that the court, the trustee and creditors can evaluate the household’s income and financial situation.

How Does Automatic Stay Work

Once the case is filed the “automatic stay” is in place which stops most collection actions against the debtor or the debtor’s property. The filing the petition does not stop certain types of actions, including but not limited to: criminal prosecutions, actions by governmental units to enforce their regulatory powers, actions to establish or modify domestic support obligations, actions to determine issues as to dissolution of a marriage, child custody or visitation, and paternity actions, and the interception of tax refunds to be applied to paternity obligations.

The automatic stay may also be limited if a prior bankruptcy case was dismissed within 1 year of the current filing. The automatic stay arises by operation of law and requires no judicial action – it’s automatic. As long as the stay is in effect, creditors generally may not initiate or continue lawsuits, wage garnishments, or even telephone calls demanding payments. The bankruptcy clerk gives notice of the bankruptcy case to all creditors whose names and addresses are provided by the debtor and severe penalties may apply to anyone violating the automatic stay.

Questions a Bankruptcy Trustee May Ask

Typical Questions that a trustee may ask include:

  • Are you employed?
  • How much do you make?
  • Did you review all the schedules which were filed on your behalf with your attorney?
  • Are they complete, accurate and truthful?
  • Are there any errors or omissions you would like to bring to my attention at this time?
  • Do you own any real property?
  • When did you purchase it?
  • How much did you pay for it?
  • What is it worth today?
  •  How did you determine the value?
  • Do you owe money on the property?
  • How much is still owed?
  • Have you sold, transferred or given away anything to anyone in the last 4 years?
  • Do you expect to inherit any property in the next year?
  • Do you have any bank accounts?
  • What is the type of account and at what bank?
  • How much is in the account?
  • What vehicles do you own?
  • What is the value of each vehicle?
  • Do you still owe money on the vehicles?
  • What is your intention regarding the vehicle?
  • Did you receive a tax refund?
  • How much?
  • Does anyone owe you any money?
  • Do you have the right to sue anybody for injuries or anything else?
  • Do you have any life insurance with a cash value?
  • Do you own any stock or interests in a business of any kind?
  • Have you made any large payments to any one creditor in the last 90 days?
  • Any payments to family members within the last year?
  • Do you pay alimony or child support?  Do you have a safe deposit box?
  • Do you own any guns or tools?
  • Do you own a boat?
  • How did you come with the value of your household goods?
  • Have you read the Bankruptcy Information Sheet provided by the United States Trustee?
  • How did you amass your debt?

These questions are meant as examples of questions a Trustee may ask at the 341 meeting.

Convert to Another Bankruptcy Chapter

In order to accord the debtor complete relief, the Bankruptcy Code allows the debtor to convert a Chapter 7 case to a Chapter 11, 12 or 13 case as long as the debtor is eligible under the new Chapter and the case has not previously been converted. Thus, the debtor will not be permitted to convert the case repeatedly from one Chapter to another.

The Role of The Bankruptcy Trustee

When a Chapter 7 petition is filed, the U.S. trustee appoints an impartial case trustee to administer the case and liquidate the debtor’s nonexempt assets. If all the debtor’s assets are exempt or subject to valid liens, the trustee will normally file a “no asset” report with the court, and there will be no liquidation or distribution of assets. Most Chapter 7 cases involving individual debtors are no asset cases. But if the case appears to be an “asset” case at the outset, unsecured creditors (creditors that cannot seize collateral) must file their claims with the court within 90 days after the first date set for the meeting of creditors. A governmental unit, however, has 180 days from the date the case is filed to file a claim.

In the typical no asset Chapter 7 case, there is no need for creditors to file proofs of claim because there will be no distribution. If the trustee later recovers assets for distribution to unsecured creditors, the Bankruptcy Court will provide notice to creditors and will allow additional time to file proofs of claim. Although a secured creditor does not need to file a proof of claim in a Chapter 7 case to preserve its security interest or lien, there may be other reasons to file a claim. A creditor in a Chapter 7 case who has a lien on the debtor’s property should consult an attorney for advice.

The Bankruptcy Estate

Commencement of a bankruptcy case creates an “estate.” The estate technically becomes the temporary legal owner of all the debtor’s property. It consists of all legal or equitable interests of the debtor in property as of the commencement of the case, including property owned or held by another person if the debtor has an interest in the property. Generally speaking, the debtor’s creditors are paid from nonexempt property of the estate. The primary role of a Chapter 7 trustee in an asset case is to liquidate the debtor’s nonexempt assets in a manner that maximizes the return to the debtor’s unsecured creditors. The trustee accomplishes this by selling the debtor’s property if it is free and clear of liens (as long as the property is not exempt) or if it is worth more than any security interest or lien attached to the property and any exemption that the debtor holds in the property.

The trustee may also attempt to recover money or property under the trustee’s “avoiding powers.” The trustee’s avoiding powers include the power to: set aside preferential transfers made to creditors within 90 days before the petition; undo security interests and other prepetition transfers of property that were not properly perfected under non-bankruptcy law at the time of the petition; and pursue non-bankruptcy claims such as fraudulent conveyance and bulk transfer remedies available under state law. In addition, if the debtor is a business, the bankruptcy court may authorize the trustee to operate the business for a limited period of time, if such operation will benefit creditors and enhance the liquidation of the estate. The individual debtor’s primary concerns in a Chapter 7 case are to retain exempt property and to receive a discharge that covers as many debts as possible.

The Bankruptcy Discharge

A discharge releases individual debtors from personal liability for most debts and prevents the creditors owed those debts from taking any collection actions against the debtor. Generally, other than cases that are dismissed or converted, individual debtors receive a discharge in more than 99 percent of Chapter 7 cases. In most cases, the bankruptcy court will issue a discharge order 60 to 90 days after the meeting of creditors.  The grounds for denying an individual debtor a discharge in a Chapter 7 case are narrow and are construed against the moving party. Among other reasons, the court may deny the debtor a discharge if it finds that the debtor:

  • failed to keep or produce adequate books or financial records
  • failed to explain satisfactorily any loss of assets; committed a bankruptcy crime such as perjury
  • failed to obey a lawful order of the bankruptcy court
  • fraudulently transferred, concealed, or destroyed property that would have become property of the estate
  • failed to complete the second debt education/counseling course.

An individual receives a discharge for most of his or her debts in a Chapter 7 bankruptcy case. A creditor may no longer initiate or continue any legal or other action against the debtor to collect a discharged debt. But not all of an individual’s debts are discharged in Chapter 7.

Non-Dischargeable Bankruptcy Debts Include:

  • alimony and child support
  • certain taxes and student loans made or guaranteed by a governmental unit
  • debts for willful and malicious injury to another entity or to the property of another
  • debts for death or personal injury caused by the debtor’s operation of a motor vehicle while the debtor was intoxicated from alcohol or other substances
  • debts for certain criminal restitution orders

The debtor will continue to be liable for these types of debts to the extent that they are not paid in the Chapter 7 case.

Debts for money or property obtained by false pretenses, debts for fraud or defalcation while acting in a fiduciary capacity, and debts for willful and malicious injury by the debtor to another entity or to the property of another entity will be discharged unless a creditor timely files and prevails in an action to have such debts declared non-dischargeable.

Revocation of the Bankruptcy Discharge

The court may revoke a Chapter 7 discharge on the request of the trustee, a creditor, or the U.S. trustee if the discharge was obtained through fraud by the debtor, if 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, or if the debtor (without a satisfactory explanation) makes a material misstatement or fails to provide documents or other information in connection with an audit of the debtor’s case.

The Reaffirmation Agreement

Secured creditors may retain some rights to seize property securing an underlying debt even after a discharge is granted. Depending on individual circumstances, if a debtor wishes to keep certain secured property (such as an automobile), he or she may decide to “reaffirm” the debt. A reaffirmation is an agreement between the debtor and the creditor that the debtor will remain liable and will pay all or a portion of the money owed, even though the debt would otherwise be discharged in the bankruptcy. In return, the creditor promises that it will not repossess or take back the automobile or other property so long as the debtor continues to pay the debt. If the debtor decides to reaffirm a debt, he or she must do so before the discharge is entered. The debtor must sign a written reaffirmation agreement and file it with the court.

The Bankruptcy Code requires that reaffirmation agreements contain an extensive set of disclosures described in the bankruptcy code. Among other things, the disclosures must advise the debtor of the amount of the debt being reaffirmed and how it is calculated and that reaffirmation means that the debtor’s personal liability for that debt will not be discharged in the bankruptcy. The disclosures also require the debtor to sign and file a statement of his or her current income and expenses which shows that the balance of income paying expenses is sufficient to pay the reaffirmed debt.

If the balance is not enough to pay the debt to be reaffirmed, there is a presumption of undue hardship, and the court may decide not to approve the reaffirmation agreement. Unless the debtor is represented by an attorney, the bankruptcy judge must approve the reaffirmation agreement.If the debtor was represented by an attorney in connection with the reaffirmation agreement, the attorney must certify in writing that he or she advised the debtor of the legal effect and consequences of the agreement, including a default under the agreement. The attorney must also certify that the debtor was fully informed and voluntarily made the agreement and that reaffirmation of the debt will not create an undue hardship for the debtor or the debtor’s dependents. The Bankruptcy Code requires a reaffirmation hearing before a judge if the debtor has not been represented by an attorney during the negotiating of the agreement, or if there is insufficient income to pay the reaffirmed debt.