What is Chapter 7?

Chapter 7 In a Nutshell

Chapter 7 is the most common form of bankruptcy and goes by the common names of Fresh Start, Total Bankruptcy or Liquidation Bankruptcy. It usually takes about 3 1/2 months from beginning (the filing date) to forgiveness of debt (entry of the Notice of Discharge).

Forgiveness of Debt. In a Chapter 7 you are usually forgiven certain kinds of debts like credit cards, signature loans, medical debts, and auto repossession debts, even if you have been taken to court and had a judgment entered against you. Some debts are not forgiven in a Chapter 7. These include student loans, some taxes, child support, alimony, criminal restitution, fraud, motor vehicle accidents caused by drugs or alcohol, and a few others.

Exempt Property. In return for this forgiveness of debt, you agree to keep only certain property (your “exempt” property), turning the rest of what you own (your “non-exempt property) over to your creditors. One of the most important items you can keep is your homestead. That means your house or mobile home and a certain amount of land. Of course, if you still owe money on your homestead, you must continue to make the mortgage payments – you don’t get a free house. Utah state law provides a limited list of exemptions (things you are allowed to keep), but here are some of the more common ones, again, property you are allowed to keep:

  • Up to $2,500 worth of an automobile beyond what is owed on it (but keep up the car payments).
  • Your washer, dryer, microwave, stove, refrigerator, freezer, sewing machine, carpets in use, beds and bedding, family clothing, and 12 months of provisions, as long as these items are not subject to a lien securing payment of a debt.
  • $1,500 worth of other household goods. That may not sound like much but we value everything at what it would bring at auction and not what it costs brand new.
  • Your 401(k) plan, IRA, KEOUGH or other ERISA qualified plan.
  • Any money you earn after you file your bankruptcy case.

Married Couples. The above list is for one person filing. If a married couple files, each person gets an identical set of exemptions. (If you are married it is not required that both file – either husband or wife can file alone). Theoretically, you turn over your excess property to the court for distribution to your creditors. However, in practice many people agree to pay to the court additional money (a “buy-back agreement”) so that they can keep most of all their property.

Surrender, Redemption, and Reaffirmation. Creditors who have collateral on their loans (car loans, mortgage loans, furniture loans) are entitled to special treatment because of the collateral. You must choose between:

Surrender. This means that you will give them back the collateral and forget the debt.

Redemption. Like surrender, but instead of surrendering the collateral, you surrender an amount of cash equal to the value of the collateral. This is rarely used because the one thing you won’t have just after filing bankruptcy is a large roll of cash to give to a creditor for redemption. However, in the District of Utah, RC Willey accepts redemption offers in installments payments over time, but, of course, at 18% interest!

Reaffirmation. You agree to be bound to this loan as if Bankruptcy had never occurred. It constitutes a complete detour around bankruptcy for the lucky creditor with whom you reaffirm the debt. Many people choose to reaffirm home or car loans, but little else makes sense for reaffirmation.

Retaining Collateral, Continue to Make Payments. In the District of Utah, there is judge-made law that allows you to retain the collateral, e.g. cars, homes, anything purchased on installment credit, and continue making payments without reaffirming or agreeing to reinstate the original loan terms. The advantage to this choice is that your personal obligation to repay the debt is discharged. For example, if your total mortgage obligations are more that your house is worth, you may choose not to reaffirm your mortgage agreement. When you sell the home, the mortgage company takes all the proceeds from the sale to satisfy the loan, but cannot pursue you for the payment deficiency. Although there doesn’t seem to be any disadvantage to this choice and I often strongly recommend that my clients avail themselves of this judge-made exception, there is at least one disadvantage to this choice that you should be aware of! If you do not reaffirm the original loan agreement, you end the contractual relationship you had with that creditor. The creditor is no longer obligated to send you account statements or balance information. You must diligently police your own account by phone or internet access to make sure your payments are current and have been made in the right amount. If you fail to keep your account current, the creditor has the same rights to foreclose or repossess under Utah state law that it had prior to your bankruptcy filing. And as a further caveat, whether this option applies to vehicle leases has not been addressed by the courts and is still open to debate in this judicial district.

Income Taxes. For income tax to be discharged, it must be more than 240 days since the tax was assessed, it must be on your own income, for a tax year for which the return was initially due (including any extensions) more than three years before the bankruptcy petition is filed, and the return must have actually been received by the IRS or the Utah State Tax Commission more than two years before the bankruptcy petition is filed.

Credit Reports. You can get a free copy of your own credit report. You may already have one. If you have applied for credit and been denied, the lender must provide you with a copy of any information they used to decide not to lend you money. If this has happened recently (within 30 days), ask the lender for a copy of the report. The major agencies are:

  • Experian: 1-800-EXPERIAN
  • Equifax: 1-800-685-1111
  • Trans Union: 1-800-916-8800
  • Credit Technologies: 1-800-445-4922

Discharge. Assuming that you have been honest in your Bankruptcy Court papers and you have not been disposing of your property to prevent your creditors from getting it (like putting your car in your son’s name so the creditors will not seize the car), the Bankruptcy Court will usually grant you your forgiveness of debt (your “Discharge”, as in “Discharge of your obligation to pay the debts”) about 3 1/2 months after you filed your Petition.

Distribution and Closing the Case. When you file your Petition, your bankruptcy case essentially splits into two rails like a railroad track. The two rails are related but they deal with different matters. One rail concerns your forgiveness of debt, “your Discharge”, and the other rail concerns the Trustee gathering up your excess property, turning it into cash, and dividing it among your creditors (“the Distribution”). Most often, there is no Distribution because there is no excess property above and beyond the debtor’s exempt property – these are called (from the Trustee’s point of view) “no asset” cases. There are, then, two paths or rails to your bankruptcy case, Discharge of debt and Distribution of excess assets, but they really have little to do with each other. Your case is not officially over until the Court produces two documents. The first is the Discharge and the other is the Order Closing the Estate. Once you get your Discharge, you can breath easily, it really doesn’t matter how long the Trustee takes (and there is no time limit) to gather up your excess assets (“the bankruptcy estate”), perform the Distribution, and ask the Court to close the case. You have what you want – the Discharge. However, many clients don’t feel really comfortable until the Court closes the estate. That can take a year or more from the filing of the petition if there are assets in the case to be distributed.

Permanent Injunction. Creditors whose debts are discharged (forgiven) are permanently enjoined (forever forbidden) from trying to collect the debt. This is referred to as the Discharge Injunction. However, creditors who have collateral on their loans (car loans, mortgage loans, furniture loans) can repossess the collateral if you default on the payments. If they do repossess, then they are not permitted to sue you for the remaining money you owe them, unless you have reaffirmed the debt.

Rebuilding Credit After Chapter 7

Within 18 to 24 months following a bankruptcy discharge, most people can qualify for a loan to buy a home, car or any other purchase on the same terms as if they had not filed bankruptcy. A creditor will focus on your debt to equity ratio and credit history following bankruptcy more than the fact that you have a bankruptcy on your record. The best way to re-build credit after a bankruptcy filing is to religiously pay all debts on or before the due date each month. However, as a general rule, you should be very cautious about buying anything on credit terms.

Keeping an Open Credit Account. Although it is an excellent idea to avoid incurring credit card debt to the extent possible, most consumers prefer to keep at least one credit card for emergency purposes.

Chapter 7 debtors are prohibited from listing some creditors in their bankruptcy while selectively excluding other, favored creditors in order to retain charging privileges, or for any other reason. You must include all creditors to whom you owe money on your bankruptcy schedules. Your bankruptcy schedules are filed under penalty of perjury. If you perjure yourself by failing to disclose all creditors to whom you owe money, the Chapter 7 Trustee may file a motion requesting that the Bankruptcy Court deny your discharge of their debt. Perjury committed in connection with a bankruptcy case is a federal crime.

However, if you have a credit card with no outstanding balance, e.g. you do not owe any money to that creditor on the day you file your bankruptcy Petition, it is not necessary for you to include this account on your bankruptcy schedules and the credit card company will not receive notice of the bankruptcy filing. You may wish to consider paying off credit cards with balances below $400.00 to enable you to emerge from their bankruptcy with their charging privileges intact. However, there is no guarantee that a creditor may discover your bankruptcy filing through some other means (such as polling credit reporting services on a regular basis) and may cancel your account anyway. It is a calculated risk that only you can make a determination about taking.

Some credit card issuers permit Chapter 7 debtors to reaffirm on credit card debt. That is, they permit you to retain charging privileges if you sign a written contract agreeing to re-pay all or a portion of the debt listed in your bankruptcy schedules. In effect, you can pay a debt that would have otherwise been discharged for the privilege of retaining your account. Again, this is another calculated risk that you should consider carefully whether reaffirming a credit card is worth the benefit of retaining charging privileges.

Some creditor card issuers even solicit new accounts from individuals who have recently come out of a bankruptcy case. Presumably on the basis that, because you are prevented from filing a Chapter 7 petition except for once every six years, there will be a greater likelihood of collection. Other creditors offer secured credit cards: you leave a deposit of $X, and can charge until you reach the $X limit. If you fail to pay, the creditor closes your account and applies your deposit to the outstanding balance.

Credit Reports. A bankruptcy filing will appear as an entry on your credit report for up to ten years. However, there is only a one-time deduction in your credit score (FICO score) and, if you pay all debts in a timely manner following your bankruptcy discharge, you are generally able to receive credit within 18 to 24 months of a bankruptcy discharge.

Chapter 7 Timeline: About 3-7 Months from Filing to Discharge

1- Bankruptcy is filed;
About 30 days until…

2- First Meeting of Creditors;
Exactly another 30 days until…

3- Deadline for objections to your claim of exemptions;
Exactly another 30 days until…

4- Deadline for filing objections to your discharge or discharge ability of a particular debt.

5- If no objections are filed under step 4, the Court will enter your Notice of Discharge as soon as the Court’s workload permits.

6- The Trustee must file a report with the Court indicating that he or she has fully administered the case. Depending on the Trustee or whether there was a distribution of assets, this report may come weeks or even years after entry of the Notice of Discharge.