Chapter 7 Basics

Chapter 7 is by far the most common type of bankruptcy. In a chapter 7 the Trustee sells all of your assets which are not exempt and distributes the proceeds to your creditors.  In return for this, you obtain a Discharge and are relieved from having to repay your debts.

Preliminarily, in order to be eligible for Chapter 7 relief a debtor must prove that such a filing would not constitute an "abuse" of the system. This is accomplished by "passing" the Means Test.

1. The Chapter 7 Trustee's liquidation of assets

In every Chapter 7 case the debtor must appear for a hearing before the Chapter 7 Trustee appointed to administer the case. This hearing is frequently referred to as either the "Section 341 Meeting" or the "First Meeting of Creditors", depending on preference, and usually occurs about four weeks after the case is filed and is held at the US Trustee's Office located on the first floor of the US Bankruptcy Court at 355 Main Street, Poughkeepsie, NY. The Trustee's primary responsibilities in a Chapter 7 case are to review the bankruptcy petition, schedules and statements filed by the debtor, examine the debtor by asking some questions at the Section 341 Meeting, and determine whether the debtor owns or has an interest in any assets that ought to be liquidated or sold in order to generate funds to pay the claims of creditor's, at least in part. In most cases (ie., approximately 95%) the Trustee determines that there are no assets worthy of liquidation, as the assets of most debtor's assets fall into four basic categories:

• Assets subject to liens. The most common examples of these are home mortgages and car loans. If the debtor owns a vacation home worth $300,000.00 that is encumbered by a mortgage totaling $350,000.00, there is no equity for a Trustee to liquidate. The Trustee will only liquidate an asset subject to a lien if there is substantial, non-exempt equity. For example, if the same vacation house above referenced was actually worth $450,000.00, the Trustee would try to liquidate the $100,000.00 non-exempt equity.
• Assets that are leased. If the debtor is leasing a vehicle, or leasing equipment used in the operation of a business, the Trustee will rarely administer these assets. The rare exception might be if the debtor has an interest in a valuable lease, such as a "rent controlled" apartment at a reduced rent or a lease for commercial property that is far below fair market value. However, even in these situations the Trustee can be confronted with many obstacles, starting with the rights of a reluctant landlord who may not want to deal with a new, and unknown, tenant.
• Assets that are exempt. New York law allows a debtor to exempt, or protect, certain assets from a Trustee's reach. In some instances an asset can be fully exempt, regardless of its dollar value, such as debtor's interest in a term life insurance policy. However, in other instances, an asset is only exempt up to a certain dollar value, such as a motor vehicle. In many instances a debtor may only be able to exempt $3,450.00 equity in a vehicle, but if the vehicle is only worth $3,000.00 the Trustee will not liquidate it because there is no value above the allowable exemption. However, if this same vehicle is actually worth $10,000.00, the Trustee will liquidate it, pay the debtor his $3,450.00 exemption and have $6,550.00 left over to pay to creditors.
• Assets with negligible value. A non-exempt asset can be owned by a debtor free and clear of liens and still not be liquidated by a Trustee if it is just not worth enough money to justify the Trustee taking the time and incurring the expense to liquidate it. An example of this is an old row boat in the backyard that may or may not still float and only cost $200.00 when purchased new ten years ago. The Trustee will not bother with this.

If the Chapter 7 Trustee examines the debtor and the filed petition, schedules and statements and determines that there are no assets to administer, said Trustee will file with the Court a Report of No Distribution, commonly referred as a No Asset Report. For this service the Chapter 7 Trustee is paid a commission of $60.00, which comes from the filing fee paid by the debtor at the outset of the case.

Occasionally a Chapter 7 Trustee determines that the debtor does possess one or more non-exempt assets that should be liquidated for the benefit of creditors. This happens in less than 5% of the Chapter 7 cases filed, and the mechanics of the liquidation process depends upon the nature of the asset.

• If the asset is "liquid" in nature, such as cash in a bank account, the Trustee directs the debtor to "turn over" the funds, which usually results in the debtor sending the Trustee a check or bank draft in the appropriate amount. If the debtor fails to cooperate the Trustee can obtain a Turnover Order from the Court directing that the debtor undertake such action. The Trustee has other, more extreme, measures at his disposal to collect such funds if the debtor is recalcitrant. If the Trustee is forced to use such extreme measures it can frequently come at a cost to the debtor, given the debtor's statutory duty to cooperate with the Trustee in the administration of the case.
• If the asset is not "liquid" in nature, such as a vacant lot or a vehicle, the Trustee's job is to take possession of the asset and locate a buyer. In furtherance of this effort the Trustee can hire professionals to assist in the marketing effort, such as hiring a realtor to sell real estate. When a buyer is located the Trustee's job is to negotiate terms and close the deal in accordance with the noticing requirements set forth in the Bankruptcy Code and Federal Rules of Bankruptcy Procedure. This entails giving all creditors and parties in interest notice of the proposed sale and an opportunity to either (1) object to the sale, or (2) make a higher or better offer. In some instances, usually involving real estate sold to third parties, the Trustee may have to obtain a Court Order authorizing the sale. Surprisingly, a high percentage of assets sold by a Trustee are sold back to the debtor. For example, if the debtor owns a vehicle free and clear of liens that is worth $8,450.00, of which only $3,450.00 is exempt, the debtor could make a slightly discounted offer to purchase the vehicle from the Trustee (actually the bankruptcy estate) for $7,450.00, which the Trustee may very well accept. In such a case, assuming that no higher or better offers are received by the Trustee, the debtor could consummate this $7,450.00 purchase by paying the Trustee the sum of $4,000.00 and waiving his $3,450.00 vehicle exemption. The debtor can actually purchase the vehicle for less "out of pocket" cash than a third party can, given the debtor's ability to waive the exemption. If a third party buys the vehicle for $7,450.00, the Trustee would have to collect the full price because he has to pay the debtor his $3,450.00 exemption from the sale proceeds.
• If the asset is "contingent" in nature, such as a personal injury claim or pending lawsuit, the Trustee's job is to hire counsel to handle the lawsuit for the benefit of the bankruptcy estate, and wait for a settlement of jury verdict. Any proposed settlement has to be approved by the Bankruptcy Judge, on notice to all creditors and parties in interest, as does the payment of the legal fee to the Trustee's counsel.
• Some assets or claims are not tangible when a Chapter 7 case is filed, yet the Trustee can administer them and generate funds for the creditors. For example, if the debtor engaged in a fraudulent transfer of property, the Trustee's job is to hire counsel to (1) set aside the transfer, restoring the debtor (actually the bankruptcy estate) as the owner, and (2) sell the asset in the manner above set forth.

A Chapter 7 Trustee has a financial incentive to liquidate assets, as he receives a commission based on the funds generated and used to pay creditors and administrative expenses.

The length of time it takes a Chapter 7 Trustee to complete the liquidation of assets is usually determined by the nature of the assets involved. Liquidating a bank account can occur in a matter of weeks, while obtaining a settlement or jury verdict on a personal injury case can take years. In any event the bankruptcy case remains open until all assets are administered and the Trustee's distribution to creditors is made, which is frequently years after debtor has been issued his Discharge.

2. The Chapter 7 Discharge

Not all debts are dischargeable in bankruptcy, and not every debtor who files a Chapter 7 petition is automatically entitled to a Discharge in every circumstance. Creditors and parties in interest, including the Chapter 7 Trustee and the US Trustee, have certain rights that they can exercise within the sixty (60) day period following the Section 341 Meeting.

Dischargeability of particular debts

Some debts are not dischargeable regardless of whether the affected creditor asserts its rights, including:

• Recent income taxes
• Domestic Support Obligations, including past and future alimony and child support, together with liabilities created by Separation Agreements or Divorce Decrees.
• Unpaid fines and penalties, such as traffic tickets.
• Student loans
• Liabilities created from operating a vehicle, boat or aircraft while under the influence of alcohol or drugs.
• Criminal restitution awards.
• Homeowners Association dues, frequently referred to as "common charges", for the period after a bankruptcy filing, for as long as the debtor owns the unit. It should be noted that common charges due and owing prior to the bankruptcy filing can be discharged.

Some debts are potentially not dischargeable if the affected creditor (1) takes timely action (ie., within the 60 day time frame) to seek a Court determination that the debt should not be discharged, and (2) ultimately prevails in such action. These potentially non-dischargeable debts all involve some form of debtor misconduct, and include those based upon:

• Credit card abuse, which is the most common, and heavily litigated, issue.
• Actual fraud.
• Embezzlement from an employer, or larceny.
• Breach of a fiduciary obligation.
• Infliction of willful and malicious injury to another person or his property.

If the affected creditor fails to take timely action, or takes timely action but does not prevail in Court, then the debt is discharged. Neither the Chapter 7 Trustee nor the US Trustee is authorized to object to the dischargeability of a particular debt. If the affected creditor does not exercise his rights, he loses them.

Debtor's right to a Chapter 7 discharge

In certain circumstances a party in interest, including a creditor, the Chapter 7 Trustee or the US Trustee, can file a complaint under Section 727 seeking to deny the debtor a discharge of all of his debts. Such complaints are rare and must be filed in a timely fashion (ie., within the 60 day period), and the grounds include:

• Transferring, removing or concealing assets in the year prior to filing, or after the filing.
• Failing to maintain adequate books and records.
• Filing materially false or misleading bankruptcy papers.
• Testifying falsely under oath.
• Failing to satisfactorily explain any loss of assets.
• Failing to cooperate with the Chapter 7 Trustee's liquidation efforts.
• Refusing to obey a Bankruptcy Court Order.

Dismissal of debtor's Chapter 7 case

A party in interest, including a creditor, the Chapter 7 Trustee or the US Trustee, can ask the Court to dismiss a Chapter 7 case involving consumer (ie., non-business) debt under Section 707 if the granting of a discharge would constitute an "abuse" of the bankruptcy process. This is a lesser standard than was required prior to the 2005 Bankruptcy Code amendments, when a finding of "substantial abuse" was required before a case could be dismissed. The grounds for such a dismissal are:

• Failing to "pass" the Means Test
• The "totality of the circumstances" of the debtor's financial situation demonstrates abuse. This comes into play when:
  • The debtor's actual budget (as opposed to the Means Test "budget") has considerable disposable income left over at the end of the month.
  • The debtor attempts to maintain a lavish lifestyle rather than paying his creditors, usually involving debtor's intent to continue making large loan payments in order to keep luxury goods such as fancy cars or boats.

Chapter 7 bankruptcy in perspective

A Chapter 7 Bankruptcy is a “last resort” option for dealing with excessive debt. In the proper circumstances it can greatly assist a financially distressed debtor. However, it does not solve a person’s “problem” - it only rids them of their unsecured debt.

A simple example will hopefully illustrate this point. If a person is unemployed, and they incur a lot of debt due to their unemployment, when they file a bankruptcy they will obtain a discharge of their debt but they will still be unemployed.

While financial irresponsibility is certainly a cause of excessive debt, it is by no means the only one, or even the primary one. Indebtedness can result from unemployment, underemployment, catastrophic health events, marital breakups, etc. While a bankruptcy filing will get rid of debt, it will not find someone a job, or a better job, or remedy health problems or patch up a shaky relationship.  Once again, it only gets rid of debt.

Will bankruptcy make you financially sound?

With the above in mind, a person considering bankruptcy really must ask themselves whether getting rid of their unsecured debt will make them financially sound and able to meet their post-bankruptcy cost of living expenses (i.e. food, clothing, car insurance, etc.) with their current income level. If the answer is “yes,” bankruptcy is certainly a viable option. If the answer is “no”, this does not necessarily mean that bankruptcy is out of the question, it just means that bankruptcy will not solve their entire problem. Something else, in addition to filing bankruptcy, may be needed before the person obtains solvency. Frequently this “something else” is a downsizing of lifestyle. Sometimes it is a second job or higher paying job, etc.

Should you file for bankruptcy?

When considering your options it is important to realize that there is no right or wrong answer to the “do I file bankruptcy?” question, and there is no one else who can really tell you what you should do. The first step is to get all of your bankruptcy-related questions answered by a competent attorney so that you can make an informed business decision. You just have to get your questions answered and make a business decision about what is best for you and your family.

The best way to achieve a bankruptcy “fresh start” is to retain the services of a competent, respected bankruptcy attorney. I hope you will consider our firm.

Call our office today at (845) 343-6227 and speak to Attorney Michael O’Leary or Michael Pinsky to arrange a free consultation to discuss your options regarding bankruptcy and other alternatives to bankruptcy.

Bankruptcy lawyers with offices in Middletown, New York serving Orange County, Sullivan County, Ulster County, Dutchess County, Rockland County, Westchester County and Putnam County and communities including Newburgh, Port Jervis, Goshen, Monticello, Liberty, Ellenville, New Paltz, Kingston, Poughkeepsie, White Plains and New City.

This Law Firm proudly practices Bankruptcy Law, helping clients file cases under Chapters 7, 13 and 11. According to the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005, we are considered to be a Debt Relief Agency.