Chapter 7 bankruptcy cases are straight liquidations sought by debtors who wish to have most or all of their debts discharged. In Chapter 7 cases, the Chapter 7 trustee obtains control over the debtor’s assets and evaluates whether any equity exists that would offset the costs of selling those assets. If the bankruptcy estate will likely profit from selling the debtor’s assets, the Chapter 7 trustee will liquidate the assets and distribute the proceeds to creditors. This is called an “asset case.”
Both individual consumers and businesses can file for Chapter 7 relief. Usually, businesses file Chapter 7 cases when they are no longer operating or when they are in the process of winding down. We’ve put together a high-level overview or “lifecycle” of a Chapter 7 case, emphasizing concepts and milestones of particular importance for creditors. Additionally, we have created a preliminary checklist that will help you navigate the early stages of Chapter 7 bankruptcy.
Liquidation of Assets and Exemptions
Often, Chapter 7 debtors have little to no assets to liquidate, and the Chapter 7 trustee will file a “report of no assets.” Contrast this with debtors who have substantial equity in assets that they wish to retain. Such debtors will file for Chapter 13 or Chapter 11 bankruptcy, where they can propose a plan to repay their creditors over time and can otherwise be permitted to keep most of their assets.
Debtors can retain some assets by claiming them as “exemptions” under Section 522, which are disclosed on Schedule C. Depending on the state in which a debtor files for bankruptcy, either the Bankruptcy Code’s federal exemptions or the particular state’s exemptions may be claimed in the bankruptcy case. For instance, in Florida, debtors may claim 100% of the equity in their homestead (personal residence) as exempt pursuant to Florida law. On the other hand, debtors in Illinois can only claim either $15,000, or $30,000 for married couples filing jointly, of the equity in their homestead as exempt under Illinois law.
Trustee’s Determination of Assets and Liquidation
A typical Chapter 7 case only lasts a few months. After the debtor files his petition for relief, the Chapter 7 trustee will hold the 341 meeting of creditors, so named because it refers to Section 341 of the Bankruptcy Code. At the 341 meeting, the trustee will question the debtor about the information included on his schedules and statements and determine whether the debtor has sufficient equity in any non-exempt assets such that the trustee should liquidate them. Creditors may attend the 341 meeting and will generally be permitted limited time to ask the debtor questions. If the trustee determines that the debtor does not have sufficient assets to liquidate, the trustee will file a report of no assets.
However, if the trustee decides that there are assets in the estate that can be liquidated and distributed to creditors, the trustee will file a notice instructing creditors to file proofs of claim by a certain deadline. A proof of claim describes how much the debtor owed a creditor as of the date the bankruptcy petition was filed. The claim is designated as either secured or unsecured, and documents supporting the existence of the claim (as well as perfection of any security interests) are attached.
After the trustee liquidates the estate’s assets, he will distribute the proceeds among the creditors that filed proofs of claim according to the priority scheme in Section 507 of the Bankruptcy Code and the order of distribution in Section 726 of the Bankruptcy Code. Accordingly, it is very important for creditors to watch for notices of deadlines to file proofs of claim in Chapter 7 asset cases and ensure their proofs of claim are timely filed so they can receive at least a pro rata distribution of their total debt.
The Automatic Stay and Stay Relief
When a debtor files a petition for bankruptcy relief, the automatic stay is immediately and automatically imposed. This stay acts as an order halting all collection efforts. This includes initiating or continuing lawsuits, wage garnishments, or even telephone calls demanding payments. A creditor violating the automatic stay by continuing or initiating collection efforts during the stay period can be subject to potentially significant liability.
For collateral wholly secured by a creditor’s claim and unnecessary for a reorganization, secured creditors may file a motion seeking to lift the automatic stay. After the stay is lifted, creditors can proceed to foreclose or take other in rem action against the property that is no longer subject to the stay. More information about the automatic stay and stay relief will be included in future blog posts.
Chapter 7 Discharge
After the 341 meeting and the deadline for objecting to the debtor’s discharge or dischargeability of debts passes, so long as no objections have been filed and the debtor is otherwise eligible, the Bankruptcy Court will enter an order of discharge for the debtor. Chapter 7 debtors must fulfill the requirements set forth in Section 727 to earn their discharge. Creditors, the trustee, or the United States Trustee can object to the debtor’s discharge, alleging that the debtor does not satisfy one or more of Section 727’s requirements. Additionally, creditors or the Chapter 7 trustee can object to the dischargeability of one or more of a debtor’s particular debts under Section 523. More information about objections to discharge and dischargeability will be detailed in future blog posts.
The discharge order provides that the debtor’s discharged debts can no longer be collected. Creditors that attempt to collect discharged debts can be found liable for discharge injunction violations, which can be extremely costly. As such, creditors should pay close attention when notice of a discharge is received and immediately update their records accordingly to avoid any inadvertent discharge injunction violations.
Notably, only individual Chapter 7 debtors may receive a discharge. Businesses that file for Chapter 7 bankruptcy are not eligible for a discharge.
A Note about the Means Test
The Bankruptcy Code was revised in 2005 by the Bankruptcy Abuse Prevention and Consumer Protection Act (BAPCPA). One of the changes BAPCPA brought was the “means test,” which determines a debtor’s eligibility for Chapter 7 bankruptcy relief. Briefly stated, the means test separates those debtors who earn sufficient monthly disposable income from those who cannot afford to repay their creditors anything. Those debtors with more disposable monthly income than allowed under the means test are subject to dismissal from Chapter 7 and can instead seek relief under Chapter 13 or Chapter 11, in which they would repay their creditors over time pursuant to a repayment plan.