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Chapter 7 Bankruptcy Overview

Written by: Jeffrey Erich Foster

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Bankruptcy Chapter 7 Bankruptcy Filing for Bankruptcy

Posted almost 3 years ago. 4 helpful votes, 0 comments

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What is Chapter 7

Chapter 7 is a type of bankruptcy case that allows people to eliminate unsecured debt and earn a fresh start in life. Most Chapter 7 cases last about 90 days and relief from lawsuits and debt collectors is available immediately after the case is filed with the bankruptcy court. At the conclusion of a Chapter 7 case, a discharge is entered by the bankruptcy court. A discharge is a court order signed by a bankruptcy court judge granting debt relief for all “dischargeable debts”. Debts eligible for discharge in Chapter 7 include: • Credit card debt • Medical debt • Auto repossession debt • Foreclosure debt.

Eligibility

The bankruptcy law changes in 2005 created a test for people filing Chapter 7 (and Chapter 13) called the means test. The means test contains two components: 1. Median income test and 2. Disposable income test. The median income test involves a comparison between Washington’s median income for your family size against your actual household gross income earned over the six months prior to the bankruptcy filing. For example, if the median income for a family size of one in Washington is $50,000 and you are a single person who has earned less than $25,000 (gross income) over the last six months then you qualify under the median income test for Chapter 7. The disposable income test involves deducting various expenses from your monthly income. Deductions include income tax withholding, mortgages, auto loans, health care, as well as standard deductions for rent, food, utilities and living expenses.

Eligibility continued

If the amount left over after the deduction of your "allowed living expenses", multiplied by 60, is less than 25% of what you owe to your "nonpriority, unsecured" creditors or $10,000, you are eligible to file Chapter 7. For example, let's say you have $150 left over each month, and owe $50,000 to your "nonpriority, unsecured" creditors. Since $150 x 60 = $9,000 and $9,000 is less than 25% of $50,000 (which is $12,500), you would be eligible to file Chapter 7. In addition to the means test, there are several other considerations to take into account when making the decision to file Chapter 7. A discharge is only available to those who have not received a discharge in Chapter 7 in the last 8 years. In other words, a Chapter 7 bankruptcy case can only be filed once every 8 years.

Benefits of Chapter 7

1. Discharge of Debt. First and foremost, by filing Chapter 7 and obtaining a discharge, you are able to eliminate a wide array of unsecured debt. This allows you to receive a fresh start and not have to stress over past debt problems. As stated above, the discharge is a court order that restricts creditors from collecting debt eliminated in Chapter 7. Once your Chapter 7 case has been discharged, eliminated debt is gone forever. In fact, if a creditor attempts to collect on a debt eliminated in Chapter 7, the creditor faces steep civil penalties. 2. Automatic Stay. When a Chapter 7 bankruptcy case is filed, an automatic stay goes into effect immediately upon filing. The automatic stay is a federal law (11 U.S.C. 362) enacted by Congress to prohibit most creditors from continuing collection efforts after a bankruptcy has been filed. Such collection efforts include phone calls, letters, lawsuits, judgments, garnishments, foreclosures and repossessions.

Benefits of Chapter 7 cont'd

3. Retaining your assets. Most Chapter 7 cases are “no-asset” cases. This means that most people do not lose any assets when filing Chapter 7. State and federal laws called exemptions are available to protect all types of property from liquidation in Chapter 7. In the state of Washington, homes are protected from liquidation if there is less than $125,000 in equity. Equity means the difference between the value of the home and the mortgages and other liens on the home. Additionally, there is currently an (approximately) $11,000 exemption to protect all personal property (separate exemption is available for household goods) for a single filer and (approximately) $22,000 for husband and wife if you do not need to use a homestead exemption.

Benefits of Chapter 7 cont'd

4. Credit Repair. This may sound contrary to what you may have heard, but Chapter 7 can actually improve your credit. One of the main components of the credit score and your creditworthiness is the debt-to-income ratio (“DTI”). The DTI compares the amount of your debt against your income. Prior to your Chapter 7 filing, your DTI is likely quite high given credit card and other unsecured debt balances. After you receive a discharge in Chapter 7, your DTI decreases substantially. Lowering your DTI, combined with obtaining or re-affirming credit lines after bankruptcy may result in a significant improvement in your credit score after your Chapter 7 filing. In fact, you will receive several offers for new credit during your Chapter 7 case. Clients report to me that they are shocked at how easy they were able to obtain credit after their Chapter 7 case is discharged.

Benefits of Chapter 7 cont'd

5. Fresh Start. In addition to the benefits described above, the psychological benefit of relieving yourself of debt and obtaining a fresh start may be the biggest benefit of filing Chapter 7. The stress of debt can result in marital and family strife as well as sleepless nights and difficulties at your job. The piece-of-mind gained after a Chapter 7 filing is an invaluable component in all Chapter 7 cases. Most clients feel the weight of the world fall off their back after meeting with our attorney and learning that there is an answer to their debt problems.

Disadvantages to Chapter 7

1. Dealings with family members. First, if you have repaid family members over the past year (and in certain circumstances over the last three years) over certain dollar amounts, the Chapter 7 trustee will initiate legal proceedings against the family member to reclaim the funds received by the family member over the last year. This is called a preference since you have chosen to repay a family member instead of your other creditors. In fairness to the other creditors, the trustee will reclaim the preferential payment and disburse it pro-rata amongst all creditors during your Chapter 7 case. In addition to payments to family members, any transfer of assets to a family member in the three years prior to your Chapter 7 bankruptcy filing must be disclosed and discussed with our attorney before you file your case. If an asset is transferred to a family member, the Chapter 7 trustee will likely initiate a lawsuit against the family member in order to set aside or rescind the transf

Disadvantages cont'd

2. Recent credit activity. If you have made charges in the last 60-90 days prior to your Chapter 7 filing, such charges may be deemed fraudulent in your Chapter 7 case. There is a presumption of fraud for any and all charges made immediately prior to your Chapter 7 filing date. If you have made charges prior to filing your Chapter 7 case and the creditor files a lawsuit against you for fraud, you may be forced to repay these sums as well as interest and attorney’s fees incurred by the creditor to sue you.

Disadvanatages cont'd

Because Chapter 7 is a liquidation bankruptcy, all non-exempt assets will be sold by the Chapter 7 trustee and the proceeds distributed to your creditors. If you fail to disclose an asset in your Chapter 7 case, you will likely lose the asset even if you could have claimed an exemption to protect the asset. Assets that people sometimes fail to disclose in Chapter 7 are automobile accident claims, employment/disability claims, inheritances, interests in trusts, and money owed pursuant to a promissory note or other debt. Chapter 7 bankruptcy trustees are experienced in locating assets and have access to databases that can track property ownership throughout the United States. I liken a Chapter 7 trustee to a forensic accountant in terms of their ability to find undisclosed assets.

Debts not eligible for discharge in Chapter 7

Although Chapter 7 eliminates many types of unsecured debt, there are certain debts that cannot be discharged in Chapter 7, such as: • State and federal tax debts (there are some tax debts that are eligible for discharge) • Debts not listed in your Chapter 7 case • Child support, alimony and maintenance obligations • Debts assigned to a spouse in a divorce decree (these debts are dischargeable to the creditor, i.e. Discover card, but not to the ex-spouse) • Student loans, both federal and private • Traffic tickets, parking tickets, criminal restitution • Debts resulting from an automobile accident where alcohol or drugs were involved • Debts involving fraud or fiduciary malfeasance.