Chapter 7 Bankruptcy

In a chapter 7, the bankruptcy trustee gathers and sells the debtor’s nonexempt assets and uses the proceeds of such assets to make a one-time payment to creditors. Part of the debtor’s property may be subject to liens and mortgages that pledge the property to other creditors.

Fortunately, the Bankruptcy Code and Nevada state law allow individuals in Chapter 7 to keep most of their property as being “exempt” from the trustee, but a trustee will take and sell all non-exempt property. Nevada has very generous exemptions, but even then some individuals do have loss of property. If you’re concerned about whether your property is exempt, please call us for a consultation.

Advantages of Chapter 7

Chapter 7 bankruptcies are generally quick (3-4 months) and, unlike chapter 13, no plan has to be filed.

Filing the petition under chapter 13 “automatically stays” (stops) most collection actions against the debtor or the debtor’s property. Filing the petition does not, however, stay certain types of actions listed under 11 U.S.C. § 362(b), and the stay may be effective only for a short time in some situations. The stay arises by operation of law and requires no judicial action. As long as the stay is in effect, creditors generally may not initiate or continue lawsuits, wage garnishments, or even make 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.

In a Chapter 7 bankruptcy, debtors who are current on their house mortgages almost always get to keep their house (if they choose to keep it), providing that they continue to make timely payments on their mortgage.

Chapter 7 Eligibility

To qualify for relief under chapter 7 of the Bankruptcy Code, the debtor may be an individual, a partnership, or a corporation or other business entity.

Individuals whose debts are primarily consumer debts have to pass a “means test” to qualify for chapter 7. If the debtor’s “current monthly income” is more than the state median for their household size, then chapter 7 is not available, and debtors must file chapter 13 or chapter 11 instead.

Individuals whose debts are primarily business debts do not have to pass the means test.

Subject to the means test for individual debtors, chapter 7 is available irrespective of the amount of the debtor’s debts.

How Chapter 7 Works

A chapter 7 case begins with the debtor filing a petition 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. (3) In addition to the petition, the debtor must also file with the court: (1) schedules of assets and liabilities; (2) a schedule of current income and expenditures; (3) a statement of financial affairs; and (4) a schedule of executory contracts and unexpired leases.

Debtors must also provide the assigned case trustee with a copy of the tax return or transcripts for the most recent tax year as well as tax returns filed during the case (including tax returns for prior years that had not been filed when the case began). Individual debtors have additional document filing requirements, including providing a certificate of credit counseling, evidence of payment from employers or other sources of income; and schedules of monthly income and expenses.

A husband and wife may file a joint petition. Married individuals must provide all information about the couple’s financial situation 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, the income and expenses of the non-filing spouse is required so that the court, the trustee and creditors can evaluate the household’s financial position.

When an individual files a chapter 7 bankruptcy, a trustee is appointed to administer the case. The chapter 7 trustee both evaluates the case and serves as a liquidation/disbursement agent, selling all non-exempt assets of the debtor and making a distribution to creditors.

About 45 days after the petition is filed, the chapter 7 trustee will hold a meeting of creditors. During this meeting, the trustee puts the debtor under oath, and both the trustee and creditors may ask questions. The debtor must attend the meeting and answer questions regarding the debtor’s financial affairs and property. If a husband and wife have filed a joint petition, they both must attend the creditors’ meeting and answer questions.

Role of the Case Trustee

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 distribution to unsecured creditors. Most chapter 7 cases involving individual debtors are no asset cases.

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 time to file proofs of claim.

Commencement of a bankruptcy case creates an “estate.” The estate technically becomes the temporary legal owner of all of 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.

Section 726 of the Bankruptcy Code governs the distribution of the property of the estate. Under § 726, there are six classes of claims; and each class must be paid in full before the next lower class is paid anything. The debtor is only paid if all other classes of claims have been paid in full. Accordingly, the debtor is not particularly interested in the trustee’s disposition of the estate assets, except with respect to the payment of those debts which for some reason are not dischargeable in the bankruptcy case. 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.

Reaffirmation of Debt

Depending on individual circumstances, if a debtor wishes to keep certain secured property with a loan on it (such as a house or 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.

The Chapter 7 Discharge

One of the primary purposes of bankruptcy is to discharge certain debts to give individuals a fresh start. The debtor has no liability for discharged debts.

In a chapter 7 case, however, a discharge is only available to individual debtors, not to partnerships or corporations. Although an individual chapter 7 case usually results in a discharge of debts, the right to a discharge is not absolute, and some types of debts are not discharged. Moreover, a bankruptcy discharge does not extinguish a lien on property.

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, excluding cases that are dismissed or converted, individual debtors receive a discharge in more than 99 percent of chapter 7 cases. In most cases, unless a party in interest files a complaint objecting to the discharge or a motion to extend the time to object, the bankruptcy court will issue a discharge order relatively early in the case – generally, 60 days after the date first set for 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; or failed to complete an approved instructional course concerning financial management.

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. Debts not discharged include debts for alimony and child support, certain taxes, debts for certain educational benefit overpayments or loans made or guaranteed by a governmental unit, debts for willful and malicious injury by the debtor to another entity or to the property of another entity, 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, and 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.

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.