What Is a Chapter 7 Bankruptcy?

People sometimes come into my office and tell me they want to file a Chapter 7 bankruptcy. I listen to them as they tell me about their debts, their assets, their income, and their financial dealings. While I sometimes agree that a Chapter 7 bankruptcy may be their best course of action, I sometimes have to wave my red flag of warning in order to avoid a disaster caused by charging into a Chapter 7 bankruptcy without considering all the rules and consequences.

I wanted to talk about a Chapter 7 bankruptcy (also known as a Liquidations). In another post I’ll share more about Chapter 13 bankruptcies (also known as a Reorganizations).

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While Both bankruptcies are designed to financially rehabilitate the person (or get the person back on their feet), the way the two bankruptcies work are very different. These differences affect the rights of the debtors in different ways.

Chapter 7 Bankruptcies

In a Chapter 7 bankruptcy, the basic approach is to liquidate the non-exempt assets of the debtor and cancel any ongoing obligations he may have with his creditors. Examples include:

  • mortgage obligation
  • car note or lease
  • apartment lease
  • rent-to-own contracts

After canceling these obligations, any property that secures these obligations is generally surrendered back to the creditor. If the debtor needs to keep the contract and finish paying for the item, there are provisions in bankruptcy for that as well. The Chapter 7 Trustee then takes any non-exempt assets, sells them, and uses the proceeds to pay as much debt as he can. With a few exceptions, those debts that are not paid by the Trustee may be discharged or wiped out.

The objective of the Chapter 7 bankruptcy is to rid the debtor of all dischargeable financial obligations and give the debtor a starting place where he can begin anew and start over.

Risks

One of the bigger risks in a Chapter 7 bankruptcy is that you may lose some asset that you did not wish to lose. In some situations, these assets could include a home, bank accounts, vehicles, lawsuits, and other things. Additionally, some gifts, transfers, or debt payments to other people may be clawed back by the trustee to redistribute to the various creditors. This could be awkward if you have recently paid off a debt to a family member or otherwise given a gift to someone. Additionally, if some of your assets are co-owned by other individuals, such as a piece of real estate that you and your siblings inherited, it may be subject to seizure and sale by the trustee.

If you have vulnerable assets or have made significant gifts or transfers of property or have paid debts you owed to family members or business insiders, you should consider the ramifications of Chapter 7 before filing.

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