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Chapter 7 Bankruptcy: How Ch. 7 Works

Chapter 7 bankruptcy laws enables individuals or businesses to have assets sold by a trustee with the proceeds used to repay creditors. Only individuals, however, may use this legal process to discharge debts, which legally erases them and ends all future obligations to pay. Creditors may not pursue payment for debts once they are discharged by a court.

A person must pass a means test to become eligible to file for this form of bankruptcy protection. The test involves an evaluation of a person's income and debts. As long as a person passes the means test to qualify for Chapter 7, any amount of unsecured debts could potentially be removed by court action. Some debts, specifically child support, cannot be removed through this process. Student loan debt can be discharged under very limited circumstances.

Both federal and state laws exempt certain assets from liquidation during a bankruptcy. Some states allow a person to follow either state guidelines or federal guidelines. Typically, a court will not force the sale of a person's primary residence or vehicle. New York state law, for example, protects a house, condominium or mobile home up to a certain value.

Case Filing Process

Sometimes a financial problem like a lawsuit, a foreclosure notice or the threat of wage garnishment causes someone to investigate how to file for bankruptcy. A consumer's first step would be to locate the bankruptcy court that serves the region where the debtor lives. The federal government operates 90 bankruptcy courts throughout the nation. Each regional bankruptcy court will require a petition that describes the need for debt relief along with the following attachments or schedules:

  • List of assets and debts
  • Description of income and living expenses
  • Statement about all finances
  • Information about existing contracts and leases
  • One or more tax returns
  • Evidence of credit counseling

A debtor must obtain and organize many financial records to submit when filing bankruptcy forms. A married person will also need to disclose information about the other spouse's finances regardless of the spouse's participation in the bankruptcy. The documents necessary for this process generally include:

  • Statements from creditors that show the amount and source of debts
  • Documentation showing income sources, amounts and payment schedules
  • A list of all property, including exempt property
  • Detailed documentation of living expenses

A court will charge filing fees in excess of $300. If debtors can show sufficient hardship, a court might allow them to pay by installments or perhaps waive the fees entirely.

Freezing Collection Activities

The filing of a Chapter 7 bankruptcy petition begins what is known as an automatic stay. This action halts the efforts of creditors to collect payments from a debtor while the bankruptcy is in progress. The court will send notices about the automatic stay to all creditors listed within a petition.

The stay presents creditors with a legal order to stop telephone calls, letters, wage garnishments or lawsuits. Depending on the details of a case, a court might exempt certain creditors from a stay or limit its time period.

The Role of the Case Trustee

After the court receives the petition, it creates a bankruptcy estate. The estate forms an entity composed of assets and debts separate from the filer. The court then assigns a trustee to manage the debtor's estate. A trustee has a duty to act impartially. Actions taken by a trustee include identifying all of the debtor's property and determining the validity of claims from creditors. When a case requires the selling of nonexempt assets, a trustee oversees the sales and pays creditors with the proceeds.

Before anything is sold, a trustee will determine if all or part of the debtor's assets are exempt. The review will also determine if any parties hold liens upon any assets. If all assets are exempt, which occurs frequently in Chapter 7 cases, the trustee will issue a no-asset report to the court. This means that no unsecured creditors will receive money. Any creditors holding secured debts need to inform the court of their claims within 90 days after the court schedules a meeting of creditors.

Meeting of Creditors

The trustee conducts this hearing, which the debtor must attend. Failing to show up for a hearing could derail the process and prevent someone from filing again for another 180 days. The hearing typically occurs about 20 to 40 days after the filing of a petition. The court also invites creditors to this meeting although they are not required to attend. They do not necessarily give up any rights by not attending. The trustee will examine the information presented by the debtor to gain a full understanding of the situation. A trustee will also want to know if the debtor understands the consequences of the bankruptcy. At this meeting, the trustee will approve the case, dismiss it or ask for more information. No judge is present.

The Role of the Bankruptcy Judge

As a petition moves through the system, a judge will make binding decisions when questions or disputes arise. These questions might concern eligibility or the classification of an asset as exempt or nonexempt. Typically, a debtor has almost no interaction with a judge on a Chapter 7 case, but the filer could get debts discharged in as little as four months. If a debtor's case passes review, a judge will grant a discharge of certain unsecured debts.

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