In Chapter 7, a debtor surrenders his or her non-exempt property to a bankruptcy trustee who then liquidates (sells) the property and distributes the proceeds to the debtor’s unsecured creditors. Upon completion of the liquidation, the debtor is entitled to a discharge of debts. When a debt has been discharged in bankruptcy, the creditor is not allowed to take any action to enforce or collect on the obligation.
Filing a petition under Chapter 7 automatically stays, at least temporarily, most collection actions against the debtor or the debtor’s property. As long as the stay is in effect, creditors generally may not initiate or continue lawsuits, wage garnishments, or even telephone calls demanding payments. The bankruptcy clerk gives notice of the bankruptcy case to all creditors whose names and addresses are provided by the debtor.
The debtor in a Chapter 7 bankruptcy is allowed to keep certain exempt property, but the trustee will liquidate the debtor’s non-exempt assets and use the proceeds to pay creditors. Many Chapter 7 debtors own only exempt property (e.g., clothes, household goods, an older car) and will not have to surrender any property to the trustee. Property exemptions vary from state to state, and it is possible that the filing of a petition under Chapter 7 will result in the loss of some of the debtor’s property.
Most unsecured debts are legally discharged at the conclusion of a Chapter 7 bankruptcy. However, certain types of debts (e.g., student loans) cannot be discharged except in rare circumstances, and others (e.g., spousal support, child support, some fines, and some taxes) cannot be discharged under any circumstances. Because the goal of most Chapter 7 debtors is to wipe the financial slate completely clean, it is important to discuss the dischargeability of each particular debt with legal counsel before filing.
The debtor may be denied a discharge of debts altogether if he or she commits certain types of unlawful or inappropriate acts (e.g., concealing records relating to financial condition); or if court determines that the bankruptcy filing is abusive. Additionally, a Chapter 7 bankruptcy can be converted to a Chapter 13 bankruptcy if it is shown that the debtor can afford to repay some or all of his or her debts within the five-year time frame provided under Chapter 13.
Generally, the rights of a secured creditor to collateral continue even though the underlying debt has been discharged. For example, absent some arrangement by a debtor to surrender a car or reaffirm the debt secured by the car, the creditor holding a security interest may repossess the car even if the debt owed to the creditor has been discharged.
When a troubled business is deeply in debt and unable to pay its creditors, it may file for bankruptcy (or its creditors may file an involuntary petition against it) under
Chapter 7. When a business files under Chapter 7, business operations cease unless continued by the trustee. The trustee generally sells the business assets and distributes the proceeds to creditors. This often means that all employees lose their jobs. However, when a large company files a Chapter 7 bankruptcy, entire divisions of the company may be sold intact to other companies during the liquidation. In the case of a corporation or partnership, once the bankruptcy estate has been fully administered, the case is closed and the entity is dissolved, but at least theoretically the debts continue to exist until applicable statutory periods of limitation expire.
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