Most people have heard of Chapter 7 bankruptcy before.
It’s the one where you wipe out all your debts (usually).
Chapter 7 bankruptcy (Title 11 of the United States Bankruptcy Code) is commonly known to attorneys, lawyers, and others as a liquidating bankruptcy (liquidation), personal bankruptcy, or just plain “bankruptcy.” It is also referred to as a consumer bankruptcy, although businesses can also file under Chapter 7.
For cases filed after October 17, 2005, eligibility to file Chapter 7 is partially determined by a means test if your annual income exceeds the median income for your geographic area as determined by the IRS. See more information on means testing.
What Happens To Your Assets in a Chapter 7?
An asset (property) is anything you own or may have a right to own at some future date (for example, if you are in someone’s will).
In Chapter 7 some, and in most cases all, of your assets will be exempt.
California law provides two separate sets of exemptions from which to choose.
See more on California Exemptions
A detailed analysis of these exemptions is not possible here. Basically, you can exempt any items normally used for your support and maintenance, such as clothing, furniture, household goods, and so forth.
After you file your case, a Trustee is appointed. He (or she) will liquidate (sell) all of your non-exempt assets and pay your creditors according to the priority afforded to them by the Bankruptcy Code.
You may voluntarily repay any debt upon agreement with the creditor after the Chapter 7 case is completed. Whether this is ever advisable is questionable and is an issue to be discussed with your attorney or lawyer.
Should you file Chapter 7 Bankruptcy in California?
The goal of most any personal bankruptcy attorney is to obtain a discharge or “bankrupt” their client’s existing debts and to allow them a *fresh start* on their finances. In other words, once your discharge is granted, you no longer need to repay the debts that were incurred before you filed your bankruptcy. Your creditors are entitled to share in the proceeds obtained from the liquidation of your non-exempt assets.
Under Chapter 7, the amount your creditors will get is fixed by the value of your non-exempt assets.
Technically, the word “bankrupt” is not the correct terminology when referring to getting rid of debts, but most people (even many attorneys) use that phrase. “I want to bankrupt my credit cards or bankrupt my student loan debts”. The correct legal term is “discharge”. You discharge your obligation to pay on debts. Throughout this webpage, that is the term that will be used to describe getting rid of (bankrupting) debts in bankruptcy.
Not All Debts Are Dischargeable in Chapter 7 Bankruptcy
Certain debts are non-dischargeable in Chapter 7 and Chapter 13. Examples of these are alimony and child support obligations, taxes less than three (3) years old, student loans (with the sole exception listed below), and any debts procured by fraud, incurring debt without a reasonably certain ability to repay the debt, and so forth. Certain debts related to a divorce proceeding, such as attorneys fees, MAY be dischargeable in a Chapter 13, but not in a Chapter 7.
Assuming you need to file a bankruptcy, the only way to determine which Chapter to file under is to first compare your options under the other available Chapters (with the assistance of a bankruptcy attorney). Generally, Chapter 7 is the cheapest, quickest and least burdensome of the three major Chapters (the others being 11 and 13) of bankruptcy law. Costs and fees vary depending on the number of creditors you have, complexity of your case, and other factors.
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If you are an individual and meet the requirements, Chapter 7 allows you to discharge most or all of your debts. It allows you to do this regardless of how many assets you have or how much your creditors ultimately receive. It basically allows you to walk away from your debts and start over.
Corporations do not receive discharges of debts, but there still may be some benefit to allowing a trustee to liquidate the assets.
What are some of the disadvantages of Chapter 7?
You are only able to receive a discharge after eight (8) years have passed since the commencement of the last case in which you received a discharge, although you can file another Chapter 13 case sooner (usually 4 years). Thus, you should not file a bankruptcy if you need the option of doing it again in the next eight years.
If you are a corporation, you must stop operating your business immediately upon filing the Chapter 7 petition. Only under extraordinary circumstances will the Trustee operate a business.
Payments made to or on behalf of any relatives within twelve (12) months prior to filing your bankruptcy case are recoverable by the Trustee in your case. That’s right. If you repaid money during that period to your brother, or made payments on a credit card that your mother let you use, they will have to pay back that money to your Trustee who will then distribute it equally to all your creditors. This is one of the biggest mistakes people make, often innocently because they don’t know they will be filing a bankruptcy, but that’s the law. It’s designed to prevent debtors from preferring one creditor over another. The same is true for non-relatives, although the lookback period for them (such as credit cards, etc.) is only ninety (90) days and most people don’t really care if their Trustee sues the credit card company to recover the money.
What about your credit after a Chapter 7 case?
The bankruptcy will appear on your credit report for up to ten (10) years after you file. Other accurate negative reports on your credit must be removed after seven (7) years (like late payments on credit cards, foreclosures, etc).
However, according to my former clients, this is usually not as big a problem as most people think. Credit lending agencies know you won’t be able to file another Chapter 7 bankruptcy for at least 8 years, and therefore, they don’t have that risk to bear.
You will not get as high a credit limit as you once had, or be able to borrow a large sum of money, but getting some credit (such as a secured credit card) shouldn’t be that difficult and you can rebuild your credit over time.
What you will likely face is higher interest rates, required higher down payments, more points, etc.
See my article on credit scores after bankruptcy for more information.
A word about credit cards and cash advances
Any debt aggregating more than $550.00 from any single creditor for non-essential,”luxury” goods, or cash advances totaling over $825.00 on a credit card, incurred or taken within 90 days prior to filing the bankruptcy, are presumed to be nondischargeable. The obvious reason for this is to discourage would-be debtors from “running up” their credit charges, then filing bankruptcy. To be safe, do not use your credit cards for anything other than food, clothing and other essentials during this two month period (actually, it’s best not to use them at all). It may also be considered grounds for objecting to your discharge if you have taken cash advances on one credit card to pay the minimum balances on the others, or if you transfer balances from one card to another shortly before filing bankruptcy. You should consult with your attorney about your personal situation. This particular provision is just a presumption of nondischargeability. It does not mean that if you wait more than 90 days you are magically free from nondischargeability issues; nor does it mean that if you file the bankruptcy within the 90 days that you won’t be able to discharge that debt. What it basically does is shift the burden of proving that the debt should or shouldn’t be discharged onto the debtor during that 90 day period (rather than on the creditor where it would otherwise be).
by Mark Markus