Traditionally, Chapter 7 has been the most common type of bankruptcy proceeding. It is available to an individual, a partnership, or a corporation or other business entity.
Chapter 7 is one of the three major options for relief under the bankruptcy code. It differs from Chapter 13 and Chapter 11 plans in that it is a liquidation bankruptcy, while the other two are reorganization bankruptcies. In Chapter 7 bankrutpcy, your non-exempt, unsecured assets will be sold and converted to cash, with the proceeds going to pay the costs of administering the case and to pay off your creditors. Debts that can not paid off from the liquidation of all of your assets are discharged--that is, eliminated.
Exempt assets are excluded from the assets that must be sold, up to the dollar amount of the particular exemption. The amount that you can "exempt" from sale depends upon your state of residence and whether that state allows you to take advantage of the federal bankruptcy exemptions, rather than your state's exemptions.
There will be a trustee appointed whose job it is to round up your assets and dispose of them for the benefit of your creditors. Depending upon where you live, you may well end up losing some of your property. Make sure that you consult the exemption rules for your state to understand what you have at stake. Also, you should have the advice of an attorney who is experienced with business bankruptcy and not a "bankruptcy mill" that churns out individual Chapter 7s and Chapter 13s.
Because consensual liens
that are secured by specific property, such as mortgages or car loans, cannot be discharged
, you must either continue to pay these debts or surrender the property to the creditor. Usually, these consensual liens will encumber enough of the value of the property, so that the remaining value will fit within an asset exemption.
A home may have mortgages and home equity loans that cover 90 percent of its value, and the remaining 10 percent may be protected by the homestead exemption. Thus, a sale of the asset would generate no proceeds for the other creditors. Accordingly, in typical cases, these assets are not sold, and in fact are retained by the debtor, who continues to pay off the liens.
With the exempt assets and encumbered assets removed from the pool, there are usually no assets available to the unsecured creditors who, in most cases, will be banks holding credit card accounts. The end result will be that these unsecured creditors will receive nothing, and the debts they are owed will be discharged.
Not every individual who is in debt is eligible to file a Chapter 7 bankruptcy. To prevent abuse of the system (and the creditors,) there is a means test. The means test is designed to force those debtors who (1) have primarily consumer debt and (2) have the ability to pay some of their debts to do so. These individuals are denied the "clean slate" of Chapter 7 liquidation and forced into a five-year repayment plan under(Chapter 13.)
The means test is based on your "current monthly income" as defined in the Bankruptcy Code. This is your average monthly income received over the six calendar months immediately before you filed your bankruptcy petition. If you are filing a "joint petition" with your spouse, his or her income is included as well. Also, included are any regular contributions to your household expenses from other sources except social security income or certain crime-victim payments.
You must file Form B 22A, Chapter 7 Statement of Current Monthly Income and Means-Test Calculation, when you file your bankruptcy petition. This will establish whether you are exempt from the means test and, if not, whether you met the test. The form walks you through the calculation of your current monthly income and allowable expenses.
The means test is applied as follows:
- Are your debts primarily "consumer debts?" If your business is the primary reason you are facing bankruptcy, then you do not have to worry about the means test. You would check Box 1B on your Form 22A. You can skip over the next questions. However, if you are facing bankruptcy because of personal credit card expenses, medical expenses or non-business judgments against you, continue to the next question.
- Is your "current monthly income" lower than the your state's median family income? If your income is lower than the median for your state, you've passed the means test and can skip the next questions. If your income is higher, then continue to the next question.
- What is your monthly disposable income? You determine your monthly disposable income by subtracting living expense amounts that have been established by the IRS. National standards are used for food, clothing, and health care, whereas local standards are used for housing, utility, and transportation expenses. These national and local standards apply, regardless of whether your own expenses are more or less than the standard amounts, although certain additional adjustments are permitted. Multiple the result by 60 to determine the amount of disposable income projected to be available over the next five years.
Is your disposable income less than 25 percent of your unsecured debt? To determine this, total up the amounts that you owe that are not secured by property. For example, credit card debt is unsecured debt; but a car loan generally is not. Then, multiply this total by 0.025. If the result is more than your disposable income, then there is a presumption of abuse. If it is less, there is no presumption of abuse and you can proceed with a Chapter 7 liquidation.
- Is your disposable income less than $7,025? If so, there is no presumption of abuse of the bankruptcy system and the "means test" will not bar you from proceeding with your Chapter 7 liquidation. If not, continue to the next question.
- Is your disposable income more than $11,725? If so, you are considered to have the means to make some level of payment to existing creditors--you have flunked the means test and are likely to be required to proceed with a Chapter 13 reorganization
- Is your disposable income is at least $7,025 but not more then $11,725? It's not clear whether you have passed or failed the means test--continue to the next question.
There are ways to appeal the presumption of abuse, but, in general, if you fail the means test you may well be better off considering other options. In The means test does allow special accommodations for active-duty military personnel, low-income veterans and those with serious medical conditions. It also does not apply to corporate or partnership bankruptcies.
In addition to the means test, an individual seeking to file Chapter 7 must complete a credit counseling course, unless he or she is incapacitated, disabled, or on active duty in a military zone.
Among the issues to be considered in a Chapter 7 filing:
- If you have any tax debts, the timing for filing the petition is absolutely critical! While many tax debts are not dischargeable in bankruptcy, some are depending upon when the taxes were assessed and the petition was filed. If you have any tax debts, cross-examine any potential bankruptcy attorney regarding which debts are dischargeable and how much time must elapse before the petition is filed. There are hundreds of cases where the debtor is stuck with otherwise dischargeable debts because the attorney filed the petition one or two days to soon.
- Certain income and assets acquired after a Chapter 7 filing may be included in your bankruptcy estate if you do not plan properly.
- Any recent transfers of assets will be examined, and may be undone, so you should proceed carefully.
- Personal liability for some debts will never be dischargeable under current law.
- Personal liability for most debts can be discharged, but most liens survive after the completion of a Chapter 7 filing.