There are two primary and general rules for a personal Chapter 7 Bankruptcy.
First: Bankruptcy eliminates any legal obligation of the debtor to pay the debts that existed when the debtor filed the Bankruptcy.
Second: the debtor's property will be taken and sold to pay the creditors.
For most individuals, Rule No. 1 is for the most part true, and Rule No. 2 is for the most part false.
To be able to file a Chapter 7 Bankruptcy a person must qualify financially using the Means Test and cannot have had a case dismissed within the last 6 months. A person can not eliminate their debts in a Chapter 7 if they filed a Chapter 7 within the last 8 years or a Chapter 13 within the last 6 years.
There are valid reasons not to file a Chapter 7 Bankruptcy, even if a person is eligible to file a Chapter 7. The primary reason not to file a Chapter 7 Bankruptcy is that one would lose significant property in a Chapter 7 Bankruptcy that they want to keep. The various reasons not to file Chapter 7 are discussed below.
Rule No. 1: Elimination of the Debt.
Most debts are eliminated in a Chapter 7 bankruptcy. The two primary exceptions to this rule are debts that are non-dischargeable and debts that a debtor agrees to pay through a reaffirmation agreement.
Non-Dischargeable debts. When an obligation to pay a debt is eliminated in bankruptcy it is said that the debt is “discharged”. What that means is that the debtor would have no legal obligation to pay the debt, nor could the debtors ever make themselves legally obligated to pay the debt. It does not mean that if the debtor has pledged property to secure the payment of the debt, the creditor could not collect the debt by taking the property and selling it to pay the debt. That is why many times people who file bankruptcy will agree to pay a debt through a reaffirmation agreement. Congress believes that people should be able to eliminate certain debts in a Chapter 7 Bankruptcy. These are called non-dischargeable debts. The following are some of the non-dischargeable debts:
- Most Taxes (for more see the special topic: taxes)
- Support Obligations for children and spouses
- Obligations that come from Divorces or Separation Agreements (see special topic: divorce)
- Student Loans unless you can show the payment would cause an undue hardship (See special topic: Student Loans)
- Obligations for injuries caused while drunk driving
- Many debts are related to fraud false statements, or outright theft.
Denial of Discharge. If a debtor is not honest about their property and transfers of their property or they refuse to cooperate with the Trustee (the person who handles your bankruptcy) then the Court might deny them a discharge of all of their debts.
Rule No. 2. Loss of property.
People who file bankruptcy are often able to keep three kinds of property:
- Exempt property,
- Property that is fully encumbered with debt, and
- Property that has no value or can not be sold.
Even though ultimately a debtor in bankruptcy will be able to keep this property, the debtor should not be sell anything until the case is closed or their attorney tells them that they can sell it.
Exempt Property. The property that a debtor is allowed to keep in bankruptcy is usually the same property that a creditor could not take even if the debtor had not filed a bankruptcy. It is called exempt property. Each state has different exemption laws and the Bankruptcy Code has exemption laws that also can apply. Wyoming's exemption law is the same for bankruptcy and non-bankruptcy situations. Some states have different sets of exemption laws and the debtor can choose an exemption plan that works best. The specifics of Wyoming exemption law are discussed in the Special Topics Exemptions.
Fully Encumbered Property. This is a property that the Bankruptcy Trustee does not want because there are liens and/or mortgages against the property that equal or exceed the value of the property. The debtor can keep this property if the debtor pays the debts on the property. If not then the creditors will take the property and sell it to pay off the liens or mortgages.
Property with no or nominal market value. This will include non-pedigreed pets, costume jewelry, and similar items that could not be sold for much money. The debtor can keep these things only because no one else wants them. So, unfortunately, that heap of junk cars on the street that does not start will probably not be taken by the trustee.
The Means Test.
The Means Test was enacted in 2005 because Congress was convinced by the credit industry that too many people who could pay their debt were filing for bankruptcy. The test is a two-stage test. The first stage calculates the gross income of the household for the 6 months before filing bankruptcy. If the household income is less than the state median income for the size of the family, the debtor can file either a Chapter 7 or a Chapter 13. If the household income is higher than the median income, then a complicated set of calculations based upon the actual and allowed expenses of the family are performed to determine if “there are sufficient funds to repay” a significant amount of the debt. This is called the “Means Test” – if a debtor has enough disposable income then the only kinds of Bankruptcies which they can file are Chapter 13, Chapter 11, or for family farmers, Chapter 12.
Reasons not to file a Chapter 7 Bankruptcy.
- Property with equity that is not exempt. If the debtor wants to keep such property then there are two choices: pay to the Chapter 7 trustee the market value for the property or pay at least the value of the property to unsecured creditors through a Bankruptcy Plan (Chapter 13, 12, or 11).
- Loans on Personal Property that the debtor is backward on. Usually, creditors love to have a debtor pay back a loan where the property on the loan is worth less than the amount of the loan. Most repayment bankruptcy plans will only pay to these creditors the value of the property. If the property is not necessary for the debtor of the family and is considered to be a luxury item, many courts will not allow a debtor to keep this property in a repayment bankruptcy.
- Delinquent Loans on vehicles for personal use. There is a delinquent automobile loan, and the debtor wants to keep the vehicle. Often, the only way to keep the vehicle or property is to use Chapter 13 to pay back the loan. If the car loan was not to purchase the vehicle or the loan is more than 910 days old (about 2 ½ years old) then the debtor may be able to only pay back the value of the vehicle instead of the higher loan balance. Sometimes, in a Chapter 7 case, we can find lenders who are willing to lend a debtor money to “redeem” a newer vehicle for its value.
- Late/Delinquent Mortgage or Lien Payments. In Chapter 13 there are two ways to deal with delinquent payments. If the regular payments on the loan would last longer than the length of the Chapter 13 plan (36 months to 60 months) a debtor can make payments through the bankruptcy to bring loans current, while making direct payments to the creditor. Otherwise, a debtor can pay the loan entirely through the plan.
- Significant debts that are not dischargeable. Some debts can be discharged in Chapter 13 that can not be discharged in Chapter 7, such as debts for fraud or misconduct. Some debts that are not dischargeable, such as child support and taxes can be paid over time in Chapter 13.
- A recent bankruptcy. (6 years for a Chapter 13, 8 years for a Chapter 7). In such case, Chapter 7 does not provide for a discharge of debts and to eliminate debts a debtor must use a payment bankruptcy such as Chapter 12 or 13.
What happens in a Chapter 7 Bankruptcy?
The step-by-step process of a Chapter 7 bankruptcy is evaluated here.