Bankruptcy Information:
BANKRUPTCY CHAPTER 7 explained
by the U.S. Bankruptcy Court:
ALTERNATIVES TO CHAPTER 7
Debtors should be aware that there are
several alternatives to chapter 7 relief.
For example, debtors who are engaged
in business, including corporations,
partnerships, and sole proprietorships,
may prefer to remain in business and
avoid liquidation. Such debtors should
consider filing a petition under chapter
11 of the Bankruptcy Code. Under chapter
11, the debtor may seek an adjustment
of debts, either by reducing the
debt or by extending the time for repayment,
or may seek a more comprehensive
reorganization. Sole proprietorships
may also be eligible for relief under
chapter 13 of the Bankruptcy Code.
In addition, individual debtors who
have regular income may seek an adjustment
of debts under chapter 13
of the Bankruptcy Code. Indeed, the
court may dismiss a chapter 7 case filed
by an individual whose debts are primarily
consumer rather than business
debts if the court finds that the granting
of relief would be a substantial abuse of
the provisions of chapter 7. 11 U.S.C.
§ 707(b). A number of courts have concluded
that a chapter 7 case may be dismissed
for substantial abuse when the
debtor has the ability to propose and
carry out a workable and meaningful
chapter 13 plan.
Debtors should also be aware that
out-of-court agreements with creditors
Chapter 7 of the United
States Bankruptcy Code is
the Bankruptcy Code’s
“liquidation” chapter.
Lawyers sometimes refer
to it as a “straight
bankruptcy.” It is used
primarily by individuals
who wish to free themselves
of debt simply and
inexpensively, but may
also be used by businesses
that wish to liquidate and
terminate their business.
12 • LIQUIDATION UNDER THE BANKRUPTCY CODE
or debt counseling services may provide
an alternative to a bankruptcy filing.
BACKGROUND
The potential chapter 7 debtor should
understand that a straight bankruptcy
case does not involve the filing of
a plan of repayment as in chapter 13,
but rather envisions the bankruptcy
trustee’s gathering and sale of the
debtor’s nonexempt assets, from which
holders of claims (creditors) will receive
distributions in accordance with the
provisions of the Bankruptcy Code.
Part of the debtor’s property may be
subject to liens and mortgages that
pledge the property to other creditors.
In addition, under chapter 7, the individual
debtor is permitted to retain certain
“exempt” property. The debtor’s
remaining assets are liquidated by a
trustee. Accordingly, potential debtors
should realize that the filing of a petition
under chapter 7 may result in the
loss of property.
In order to qualify for relief under
chapter 7 of the Bankruptcy Code, the
debtor must be an individual, a partnership,
or a corporation. 11 U.S.C.
§§ 109(b); 101(41). Relief is available
under chapter 7 irrespective of the
amount of the debtor’s debts or
whether the debtor is solvent or insolvent.
An individual cannot file under
chapter 7 or any other chapter, however,
if during the preceding 180 days a
prior bankruptcy petition was dismissed
due to the debtor’s willful failure
to appear before the court or comply
with orders of the court or the
debtor voluntarily dismissed the previous
case after creditors sought relief
from the bankruptcy court to recover
property upon which they hold liens.
11 U.S.C. §§ 109(g), 362(d) and (e).
One of the primary purposes of
bankruptcy is to discharge certain debts
to give an honest individual debtor a
“fresh start.” The discharge has the
effect of extinguishing the debtor’s personal
liability on dischargeable debts.
In a chapter 7 case, however, a discharge
is available to individual debtors
only, not to partnerships or corporations.
11 U.S.C. § 727(a)(1). Although
the filing of an individual chapter 7
petition usually results in a discharge of
debts, an individual’s right to a discharge
is not absolute, and some types
of debts are not discharged. Moreover,
a bankruptcy discharge does not extinguish
a lien on property.
HOW CHAPTER 7 WORKS
A chapter 7 case begins with the
debtor’s filing a petition with the bankruptcy
court.1 The petition should be
filed with the bankruptcy court serving
the area where the individual lives or
where the business debtor has its principal
place of business or principal
assets. 28 U.S.C. § 1408. In addition to
the petition, the debtor is also required
to file with the court several schedules
of assets and liabilities, a schedule of
current income and expenditures, a
statement of financial affairs, and a
schedule of executory contracts and
unexpired leases. Bankruptcy Rule
1007(b). A husband and wife may file a
joint petition or individual petitions.
11 U.S.C. § 302(a). (Official Bankruptcy
Forms can be purchased at a
legal stationery store. They are not
available from the court.)
In order to complete the Official
Bankruptcy Forms which make up the
petition and schedules, the debtor(s)
will need to compile the following
information:
LIQUIDATION UNDER THE BANKRUPTCY CODE • 13
1. A list of all creditors and the amount
and nature of their claims;
2. The source, amount, and frequency
of the debtor’s income;
3. A list of all of the debtor’s property;
and
4. A detailed list of the debtor’s monthly
living expenses, i.e., food, clothing,
shelter, utilities, taxes, transportation,
medicine, etc.
Currently, the courts are required to
charge a $155 case filing fee, a $39 miscellaneous
administrative fee, and a
$15 trustee surcharge (a total of $200).
The fees should be paid to the clerk of
the court upon filing or may, with the
court’s permission, be paid by individual
debtors in installments. 28 U.S.C.
§ 1930(a); Bankruptcy Rule 1006(b);
Bankruptcy Court Miscellaneous Fee
Schedule, Item 8. Rule 1006(b) limits
to four the number of installments for
the filing fee. The final installment shall
be payable not later than 120 days after
filing the petition. For cause shown, the
court may extend the time of any
installment, provided that the last
installment is paid not later than 180
days after the filing of the petition.
Bankruptcy Rule 1006(b). The $39
administrative fee and the $15 trustee
surcharge may be paid in installments
in the same manner as the filing fee. If
a joint petition is filed, only one filing
fee, one administrative fee, and one
trustee surcharge are charged. Debtors
should be aware that failure to pay
these fees may result in dismissal of the
case. 11 U.S.C. § 707(a).
The filing of a petition under chapter
7 “automatically stays” most actions
against the debtor or the debtor’s property.
11 U.S.C. § 362. This stay arises
by operation of law and requires no
judicial action. As long as the stay is in
effect, creditors generally cannot initiate
or continue any lawsuits, wage garnishments,
or even telephone calls
demanding payments. Creditors normally
receive notice of the filing of the
petition from the clerk.
One of the schedules that will be
filed by the individual debtor is a
schedule of “exempt” property. Federal
bankruptcy law provides that an individual
debtor2 can protect some property
from the claims of creditors either
because it is exempt under federal
bankruptcy law or because it is exempt
under the laws of the debtor’s home
state. 11 U.S.C. § 522(b). Many states
have taken advantage of a provision in
the bankruptcy law that permits each
state to adopt its own exemption law
in place of the federal exemptions. In
other jurisdictions, the individual
debtor has the option of choosing
between a federal package of exemptions
or exemptions available under
state law. Thus, whether certain property
is exempt and may be kept by the
debtor is often a question of state law.
Legal counsel should be consulted to
determine the law of the state in which
the debtor lives.
A “meeting of creditors” is usually
held 20 to 40 days after the petition is
filed. If the United States trustee or
bankruptcy administrator3 designates
a place for the meeting that is not regularly
staffed by the United States
trustee or bankruptcy administrator,
the meeting may be held no more than
60 days after the order for relief.
Bankruptcy Rule 2003(a). The debtor
must attend this meeting, at which
14 • LIQUIDATION UNDER THE BANKRUPTCY CODE
creditors may appear and ask questions
regarding the debtor’s financial affairs
and property. 11 U.S.C. § 343. If a husband
and wife have filed a joint petition,
they both must attend the creditors’
meeting. The trustee also will
attend this meeting. It is important for
the debtor to cooperate with the trustee
and to provide any financial records or
documents that the trustee requests.
The trustee is required to examine the
debtor orally at the meeting of creditors
to ensure that the debtor is aware of the
potential consequences of seeking a discharge
in bankruptcy, including the
effect on credit history, the ability to
file a petition under a different chapter,
the effect of receiving a discharge, and
the effect of reaffirming a debt. In some
courts, trustees may provide written
information on these topics at or in
advance of the meeting, to ensure that
the debtor is aware of this information.
In order to preserve their independent
judgment, bankruptcy judges are prohibited
from attending the meeting of
creditors. 11 U.S.C. § 341(c).
In order to accord the debtor complete
relief, the Bankruptcy Code allows
the debtor to convert a chapter 7 case to
either a chapter 11 reorganization case
or a case under chapter 13,4 as long as
the debtor meets the eligibility standards
under the chapter to which the debtor
seeks to convert, and the case has not
previously been converted to chapter 7
from either chapter 11 or chapter 13.
Thus, the debtor will not be permitted to
convert the case repeatedly from one
chapter to another. 11 U.S.C. § 706(a).
ROLE OF THE CASE
TRUSTEE
Upon the filing of the chapter 7 petition,
an impartial case trustee is appointed by
the United States trustee (or by the court
in Alabama and North Carolina) to
administer the case and liquidate the
debtor’s nonexempt assets. 11 U.S.C.
§§ 701, 704. If, as is often the case, all
of the debtor’s assets are exempt or subject
to valid liens, there will be no distribution
to unsecured creditors. Typically,
most chapter 7 cases involving individual
debtors are “no asset” cases. If the
case appears to be an “asset” case at the
outset, however, unsecured creditors5
who have claims against the debtor must
file their claims with the clerk of court
within 90 days after the first date set for
the meeting of creditors. Bankruptcy
Rule 3002(c). In the typical no asset
chapter 7 case, there is no need for creditors
to file proofs of claim. If the trustee
later recovers assets for distribution to
unsecured creditors, creditors will be
given notice of that fact and additional
time to file proofs of claim. Although
secured creditors are not required to file
proofs of claim in chapter 7 cases in
order to preserve their security interests
or liens, there may be circumstances
when it is desirable to do so. A creditor
in a chapter 7 case who has a lien on the
debtor’s property should consult an
attorney for advice.
The commencement of a bankruptcy
case creates an “estate.” The estate
technically becomes the temporary legal
owner of all of the debtor’s property.
The estate consists of all legal or equitable
interests of the debtor in property
as of the commencement of the case,
including property owned or held by
another person if the debtor has an
interest in the property. Generally
speaking, the debtor’s creditors are paid
from nonexempt property of the estate.
The primary role of a chapter 7
trustee in an “asset” case is to liquidate
LIQUIDATION UNDER THE BANKRUPTCY CODE • 15
Upon the filing of
the chapter 7
petition, an impartial
case trustee is
appointed by the
United States trustee
(or by the court
in Alabama and
North Carolina)
to administer the
case and liquidate
the debtor’s
nonexempt assets.
the debtor’s nonexempt assets in a
manner that maximizes the return to
the debtor’s unsecured creditors. To
accomplish this, the trustee attempts to
liquidate the debtor’s nonexempt property,
i.e., property that the debtor owns
free and clear of liens and the debtor’s
property which has market value above
the amount of any security interest or
lien and any exemption that the debtor
holds in the property. The trustee also
pursues causes of action (lawsuits)
belonging to the debtor and pursues the
trustee’s own causes of action to recover
money or property under the
trustee’s “avoiding powers.” The
trustee’s avoiding powers include the
power to set aside preferential transfers
made to creditors within 90 days before
the petition, the power to undo security
interests and other prepetition transfers
of property that were not properly
perfected under nonbankruptcy law at
the time of the petition, and the power
to pursue nonbankruptcy claims such
as fraudulent conveyance and bulk
transfer remedies available under state
law. In addition, if the debtor is a business,
the bankruptcy court may authorize
the trustee to operate the debtor’s
business for a limited period of time, if
such operation will benefit the creditors
of the estate and enhance the liquidation
of the estate. 11 U.S.C. § 721.
The distribution of the property of
the estate is governed by section 726 of
the Bankruptcy Code, which sets forth
the order of payment of all claims.
Under section 726, there are six classes
of claims, and each class must be paid
in full before the next lower class is
paid anything. The debtor is not particularly
interested in the trustee’s disposition
of the estate assets, except with
respect to the payment of those debts
which for some reason are not dischargeable
in the bankruptcy case. The
debtor’s major interests in a chapter 7
case are in retaining exempt property
and in getting a discharge that covers as
many debts as possible.
DISCHARGE
A discharge releases the debtor from personal
liability for discharged debts and
prevents the creditors owed those debts
from taking any action against the
debtor or his property to collect the
debts. The bankruptcy law regarding the
scope of a chapter 7 discharge is com-
16 • LIQUIDATION UNDER THE BANKRUPTCY CODE
plex, and debtors should consult competent
legal counsel in this regard prior to
filing. As a general rule, however,
excluding cases which are dismissed or
converted, individual debtors receive a
discharge in more than 99 percent of
chapter 7 cases. In most cases, unless a
complaint has been filed objecting to the
discharge or the debtor has filed a written
waiver, the discharge will be granted
to a chapter 7 debtor relatively early in
the case, that is, 60 to 90 days after the
date first set for the meeting of creditors.
Bankruptcy Rule 4004(c).
The grounds for denying an individual
debtor a discharge in a chapter 7
case are very narrow and are construed
against a creditor or trustee seeking to
deny the debtor a chapter 7 discharge.
Among the grounds for denying a discharge
to a chapter 7 debtor are that the
debtor failed to keep or produce adequate
books or financial records; the
debtor failed to explain satisfactorily
any loss of assets; the debtor committed
a bankruptcy crime such as perjury; the
debtor failed to obey a lawful order of
the bankruptcy court; or the debtor
fraudulently transferred, concealed, or
destroyed property that would have
become property of the estate.11 U.S.C.
§ 727; Bankruptcy Rule 4005.
In certain jurisdictions, secured creditors
may retain some rights to seize
pledged property, even after a discharge
is granted. Depending on individual circumstances,
a debtor wishing to keep
possession of the pledged property,
such as an automobile, may find it
advantageous to “reaffirm” the debt. A
reaffirmation is an agreement between
the debtor and the creditor that the
debtor will pay all or a portion of the
money owed, even though the debtor
has filed bankruptcy. In return, the
creditor promises that, as long as payments
are made, the creditor will not
repossess or take back the automobile
or other property. Because there is a
disagreement among the courts concerning
whether a debtor whose debt is
not in default may retain the property
and pay under the original contract
terms without reaffirming the debt,
legal counsel should be consulted to
ensure that the debtor’s rights are protected
and that any reaffirmation is in
the debtor’s best interest.
If the debtor elects to reaffirm the
debt, the reaffirmation should be accomplished
prior to the granting of a discharge.
A written agreement to reaffirm
a debt must be filed with the court and,
if the debtor is not represented by an
attorney, must be approved by the judge.
11 U.S.C. § 524(c). The Bankruptcy
Code requires that reaffirmation agreements
contain an explicit statement
advising the debtor that the agreement is
not required by bankruptcy or nonbankruptcy
law. In addition, the debtor’s
attorney is required to advise the debtor
of the legal effect and consequences of
such an agreement, including a default
under such an agreement. The Code
requires a reaffirmation hearing only if
the debtor has not been represented by
an attorney during the negotiating of the
agreement. 11 U.S.C. § 524(d). The
debtor may repay any debt voluntarily,
however, whether or not a reaffirmation
agreement exists. 11 U.S.C. § 524(f).
Most claims against an individual
chapter 7 debtor are discharged. A creditor
whose unsecured claim is discharged
may no longer initiate or continue any
legal or other action against the debtor
to collect the obligation. A discharge
under chapter 7, however, does not discharge
an individual debtor from certain
LIQUIDATION UNDER THE BANKRUPTCY CODE • 17
specific types of debts listed in section
523 of the Bankruptcy Code. Among the
types of debts which are not discharged
in a chapter 7 case are alimony and child
maintenance and support obligations,
certain taxes, debts for certain educational
benefit overpayments or loans
made or guaranteed by a governmental
unit, debts for willful and malicious
injury by the debtor to another entity or
to the property of another entity, debts
for death or personal injury caused by
the debtor’s operation of a motor vehicle
while the debtor was intoxicated from
alcohol or other substances, and debts
for criminal restitution orders under title
18, United States Code. 11 U.S.C.
§ 523(a). To the extent that these types
of debts are not fully paid in the chapter
7 case, the debtor is still responsible for
them after the bankruptcy case has concluded.
Debts for money or property
obtained by false pretenses, debts for
fraud or defalcation while acting in a
fiduciary capacity, debts for willful and
malicious injury by the debtor to another
entity or to the property of another
entity, and debts arising from a property
settlement agreement incurred during or
in connection with a divorce or separation
are discharged unless a creditor
timely files and prevails in an action to
have such debts declared excepted from
the discharge. 11 U.S.C. § 523(c);
Bankruptcy Rule 4007(c).
The court may revoke a chapter 7
discharge on the request of the trustee,
a creditor, or the United States trustee if
the discharge was obtained through
fraud by the debtor or if the debtor
acquired property that is property of
the estate and knowingly and fraudulently
failed to report the acquisition of
such property or to surrender the property
to the trustee. 11 U.S.C. § 727(d).
NOTES
1. An involuntary chapter 7 case may
be commenced under certain circumstances
by the filing of a petition by
creditors holding claims against the
debtor. 11 U.S.C. § 303.
2. Each debtor in a joint case (both husband
and wife) can claim exemptions
under the federal bankruptcy laws. 11
U.S.C. § 522(m).
3. United States trustees and bankruptcy
administrators are responsible for establishing
a panel of private trustees to
serve as trustees in chapter 7 cases and
for supervising the administration of
cases and trustees in cases under chapters
7, 11, 12, and 13 of the Bankruptcy
Code. Bankruptcy administrators serve
in the judicial districts in the states of
Alabama and North Carolina.
4. A fee of $645 is charged for converting,
on request of the debtor, a case
under chapter 7 to a case under chapter
11. There is no fee for converting from
chapter 7 to chapter 13.
5. Unsecured debts generally may be
defined as those for which the extension
of credit was based purely upon an evaluation
by the creditor of the debtor’s
ability to pay, as opposed to secured
debts, for which the extension of credit
was based upon the creditor’s right to
seize pledged property on default, in
addition to the debtor’s ability to pay.
BACKGROUND
Chapter 13 is designed for individuals
with regular income who desire to pay
their debts but are currently unable to
do so. The purpose of chapter 13 is to
enable financially distressed individual
debtors, under court supervision and
protection, to propose and carry out a
repayment plan under which creditors
are paid over an extended period of
time. Under this chapter, debtors are
permitted to repay creditors, in full or
in part, in installments over a threeyear
period, during which time creditors
are prohibited from starting or
continuing collection efforts. A plan
providing for payments over more
than three years must be “for cause”
and be approved by the court. In no
case may a plan provide for payments
over a period longer than five years.
11 U.S.C. § 1322(d).
Any individual, even if self-employed
or operating an unincorporated business,
is eligible for chapter 13 relief as
long as the individual’s unsecured debts
are less than $290,525 and secured
debts are less than $871,550. 11 U.S.C.
§ 109(e). A corporation or partnership
may not be a chapter 13 debtor. Id.
An individual cannot file under chapter
13 or any other chapter if, during
the preceding 180 days, a prior bankruptcy
petition was dismissed due to
the debtor’s willful failure to appear
before the court or comply with orders
Chapter 13 of the
United States Bankruptcy
Code is frequently referred
to as a “wage earner”
chapter, although it is
available to individuals
with regular income
from any source, not
just wages.
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