Chapter 7 bankruptcy is a form of debt relief offered by the US Court system that allows debtors that have become insolvent, or unable to repay their debts, to discharge said debts, and remove any legal liabilities to repay them. In return, the debtor is required to liquidate any non-exempt assets to raise cash for the benefit of unpaid creditors. Fortunately for most people, state and federal exemptions will cover most of their real estate and personal property.
How does the asset liquidation work?
In every chapter 7 case, a bankruptcy trustee is assigned to evaluate the petitioner’s assets and debts, and determine what can be liquidated to raise cash. In the cast majority of chapter 7 bankruptcy case, the trustee will disregard, or “abandon”, almost all of the petitioner’s property. The reason for this is that most property is either worth too little to sell, or is too difficult to liquidate.
The two types of property that are likely to be considered for liquidation are automobiles and real estate. Both of these types of property are covered, to some degree, by the exemption laws of the state of jurisdiction. An “Exempt Asset” is one that is protected by law from liquidation.
What property is exempt from liquidation?
Exemption laws generally vary by state, but there are Federal exemptions that may or may not be available in a given state. Most states have exemption laws that consider cars, real estate, household goods, lawsuit awards, clothing, computers and electronics and most other common personal property.
Exemption laws generally cover the equity of an asset to a limit. For example, a petitioner’s equity in a home may be covered to $100,000. If a home is worth $300,000, it is possible to sell the home, give the petitioner $100,000 and use the remaining $200,000 to repay debt. In reality, the petitioner and his/her attorney will file motions and utilize legal strategies to retain these non-exempt assets. One of the legal strategies may be to choose a different chapter of bankruptcy, such as chapter 13.
What can I do to keep non-exempt assets?
There are a variety of legal options for retaining assets that otherwise might be subject to liquidation. The two most common options are redemption and reaffirmation.
Redemption
When a chapter 7 bankruptcy petitioner “redeems” an asset, he or she must offer up a lump sum of cash equivalent to the value of the equity held by the debtor, less the exemption amount.
For example, if a petitioner has a car worth $50,000, and owes $25,000 on the car note, the equity would be $25,000. If the automotive exemption in that state is $15,000, then the trustee could sell the car for $50,000, give $25,000 to the party holding the lien, $15,000 to the petitioner and the remaining $10,000 to the other debtors involved.That $10,000 is the cash equivalent that the debtor would have to produce to redeem the debt and keep the car.
Reaffirmation
Reaffirmation works by petitioning the court to keep the property out of the case, and the debtor promises to continue paying the payments as per the original loan agreement. So, in the above example, the petitioner would be able to keep the car by continuing to make the monthly car note payment as if the bankruptcy had not occurred.
What if I cannot afford my non-exempt assets?
Often times, a bankruptcy petitioner who has bought a car far outside of their budget will wonder if bankruptcy will help them keep it. If you make $45,000 annually and expect to buy a $100,000 car, you are sorely mistaken and the bankruptcy court will not abide your requests. The good news is that you can get out of unaffordable leases without owing anything.
What about my debt? What happens to that?
The US Bankruptcy Court promises debtors a “fresh start”, and that is why almost all unsecured debt is discharged, freeing the debtor from any liabilities to repay them. This includes credit card debt, medical bill debt, personal loans, payday loans and more. All of these debts are essentially “erased”, and the petitioner can start over with a financial “clean slate”.
Some types of debt are immune from discharge, like student loan debt and family support debt. In these cases, the chapter 7 bankruptcy petitioner and attorney will have to establish that repayment of these debts would prove to be an undue hardship, in which case the bankruptcy court judge can discharge them. Proving this hardship is notoriously difficult, and should not be counted on.
This sounds too good, what’s the catch?
Obviously, if anyone could get rid of their debts without consequence, no one would every repay anything. First off, chapter 7 bankruptcy can only be filed once every 10 years, so it’s not a tool to be used repeatedly.
Second, a bankruptcy will stay on a petitioner’s credit report for upwards of ten years, making getting credit more difficult. For most people considering bankruptcy, this is not a problem since maintaining a large amount of debt, and not paying it off often leaves them with no hope of raising credit and cash loans. Furthermore, if a debtor is relieved of all debts, then they have a much greater capability to maintain monthly payments on new loans, so may prove to be less risky for creditors.
The general rules is, it will take 6-12 months after a bankruptcy to get a credit score back up to above 700, where taking new loans is done with little trouble.
Will I need a lawyer for the process?
95% of bankruptcy cases are represented in court by a qualified bankruptcy attorney. Some bankruptcy petitioners are able to handle the process “pro se”, meaning they represent themselves. Choosing to hire a lawyer is a personal choice, but the courts recommend every chapter 7 bankruptcy petitioner is represented by a qualified attorney.
As a general rule, if a petitioner has any personal property that he or she want to retain, or has debts that are subject to non-dischargeability, then he/she should talk to a qualified bankruptcy lawyer before taking any steps towards petitioning the court for bankruptcy protection.
