WHAT IS CHAPTER 7 BANKRUPTCY?
Chapter 7 of Title 11 of the United States
Code (Bankruptcy Code) governs the process of liquidation under the bankruptcy
laws of the United States. (In contrast, Chapters 11 and 13 govern the process of reorganization of a debtor in
bankruptcy.) Chapter 7 is the most common form of bankruptcy in the United
States. Individuals who reside, have a place of business, or own property
in the United States may file for bankruptcy in a federal court under Chapter 7("straight bankruptcy", or
liquidation). Chapter 7, as with other bankruptcy chapters, is not available to individuals
who have had bankruptcy cases dismissed within the prior 180 days
under specified circumstances.
In a Chapter 7 bankruptcy, the individual is allowed to keep
certain exempt property. Most liens, however (such as real estate mortgages and
security interests for car loans), survive. The value of property that can be
claimed as exempt varies from state to state. Other assets, if any, are sold (liquidated)
by the interim trustee to repay creditors. Many types of unsecured debt are
legally discharged by the bankruptcy proceeding, but there are various types of
debt that are not discharged in a Chapter 7. Common exceptions to discharge include
child support, income taxes less than 3 years old and property taxes, student
loans (unless the debtor prevails in a difficult-to-win adversary proceeding
brought to determine the dischargeability of the student loan), and fines and restitution
imposed by a court for any crimes committed by the debtor. Spousal support is
likewise not covered by a bankruptcy filing nor are property settlements
through divorce. Despite their potential non-dischargeability, all debts must
be listed on bankruptcy schedules.
A Chapter 7 bankruptcy stays on an individual's credit report for
10 years from the date of filing the Chapter 7 petition. This contrasts with a
chapter 13 bankruptcy, which stays on an individual's credit
report for 7 years from the date of filing the chapter 13 petition. This may
make credit less available and/or terms less favorable, although high debt can
have the same effect. That must be balanced against the removal of actual debt
from the filer's record by the bankruptcy, which tends to improve creditworthiness.
Consumer credit and creditworthiness is a complex subject, however. Future
ability to obtain credit is dependent on multiple factors and difficult to
predict.
Another
aspect to consider is whether the debtor can avoid a challenge by the United
States Trustee to his or her Chapter 7 filing as abusive. One
factor in considering whether the U.S. Trustee can prevail in a challenge to
the debtor's Chapter 7 filing is whether the debtor can
otherwise afford to repay some or all of his debts out of disposable income in
the five year time frame provided by Chapter 13. If so, then the U.S. Trustee
may succeed in preventing the debtor from receiving a discharge under Chapter 7, effectively forcing the debtor into
Chapter 13.
It is
widely agreed amongst bankruptcy practitioners that the U.S. Trustee has
become much more aggressive in recent times in pursuing (what the U.S. Trustee
believes to be) abusive Chapter 7 filings Through these activities the
U.S. Trustee has achieved a regulatory system that Congress and most
creditor-friendly commentors have consistently espoused, i.e., a
formal means testfor Chapter 7. The Bankruptcy Abuse Prevention and Consumer Protection
Act of 2005 has clarified this area of concern by making changes to the U.S. Bankruptcy Code that include, along with many other
reforms, language imposing a means test for Chapter 7 cases.
Creditworthiness
and the likelihood of receiving a Chapter 7 discharge are only a few of many
issues to be considered in determining whether to file bankruptcy. The importance of the effects of bankruptcy on creditworthiness is sometimes
overemphasized because by the time most debtors are ready to file for bankruptcy their credit score is already ruined. Also,
new credit extended post-petition is not covered by the discharge, so creditors
may offer new credit to the newly-bankrupt.
