Chapter 7 bankruptcy is sometimes called “liquidation” bankruptcy—it cancels most types of debt, but you have to let the bankruptcy trustee liquidate (sell) your nonexempt property for the benefit of your creditors. Most people who use Chapter 7 get to keep all their property, but some states are more generous than others in this regard.
Here is a brief overview of how Chapter 7 bankruptcy works.
Filing Your Papers
To begin a Chapter 7 bankruptcy case, you must complete a packet of forms and file them with the bankruptcy court in your area. Once you file the petition, the court will send a notice of your bankruptcy filing to all of the creditors listed in your bankruptcy documents. This notice (called a “341 notice” because it is required by Section 341 of the bankruptcy code) sets a date for the meeting of creditors. (To learn more about the meeting of creditors, see What is the Bankruptcy Creditors' Meeting?.) Once you file the petition, you have 15 days to file the rest of your papers (although most people file everything at once).
The Automatic Stay
Filing your bankruptcy petition instantly creates a federal court order (called an “Order for Relief” and colloquially known as the “automatic stay”) that requires your creditors to stop all collection efforts. So, at least temporarily, most creditors cannot call you, write dunning letters, legally grab (garnish) your wages, empty your bank account, go after your car, house, or other property, or cut off your utility service or welfare benefits. The automatic stay is not absolute: Some creditors are not affected by the automatic stay, and others can get the stay lifted to collect their debts, as long as they get the judge’s permission first. (To learn more about the automatic stay, see How the Automatic Stay Protects Bankruptcy Filers.)
What Happens to Your Property
In your bankruptcy papers, you’ll be asked which items of your property you claim as exempt. Each state allows debtors to keep certain types of property or a certain amount of equity in that property.
If, after the creditors’ meeting, the trustee determines that you have some nonexempt property, you may be required to either surrender that property or provide the trustee with its equivalent value in cash.
If your nonexempt property isn’t worth very much or would be hard to sell, the trustee may “abandon” it—which means that you get to keep it, even though it’s nonexempt. As it turns out, all of the property that most Chapter 7 debtors own is either exempt or essentially worthless for purposes of raising money for the creditors. As a result, few debtors end up losing any of their property, unless the property is collateral for a secured debt.
Secured Debts in Chapter 7 Bankruptcy
If you’ve pledged property as collateral for a loan, the loan is called a secured debt. The most common examples of collateral are houses and motor vehicles. If you are behind on your payments, a creditor can ask to have the automatic stay lifted so it can repossess the property or foreclose on the mortgage. However, if you are current on your payments, you can keep the property and continue making payments as before—unless you have built up enough nonexempt equity in the property to make it worthwhile for the trustee to sell it for the benefit of your unsecured creditors.
The Bankruptcy Discharge
At the end of your bankruptcy case, you will receive a Notice of Discharge from the court. This notice doesn’t list which of your particular debts are discharged, but it provides some general information on the back of the form about what kinds of debts are and are not affected by the discharge order. In most cases, all debts are discharged except:
- debts that automatically survive bankruptcy (child support, most tax debts, and student loans are examples), and
- debts that the court has declared nondischargeable as a result of an action brought by a creditor, as might be the case for debts you incurred through fraudulent or willful and malicious acts.
Excerpted from How to File for Chapter 7 Bankruptcy, by Attorney Stephen Elias, Albin Renauer, J.D., & Robin Leonard, J.D. (Nolo).