Chapter 7 Bankruptcy

Chapter 7 bankruptcy summary:

• Chapter 7 bankruptcy can wipe out certain debts, absolving a debtor of their responsibility to pay them. 

• Chapter 7 is sometimes called a liquidation bankruptcy because you’re required to give up some possessions to be sold to pay your debts. 

• To be eligible for Chapter 7 bankruptcy, you have to pass a means test to ensure your eligibility.

Chapter 7 bankruptcy definition and meaning

Chapter 7 bankruptcy discharges (wipes out) certain debts. When debt is discharged in bankruptcy, you no longer have any legal responsibility to pay it. 

In exchange for wiping out debts, debtors (the person filing bankruptcy) may have to give up some of the things they own to a bankruptcy trustee. The trustee sells those assets and uses the money to pay the debtor's creditors. 

Not everyone qualifies for Chapter 7 bankruptcy. First, you have to pass the bankruptcy means test. 

Key concept: Chapter 7 bankruptcy allows eligible debtors to have certain debts discharged (forgiven) so they're no longer responsible for paying them. There's no minimum amount of debt needed to file Chapter 7, but it's typically aimed at people who lack the income to repay their credit cards, medical bills, personal loans, and other types of unsecured debt.

Chapter 7 bankruptcy basics

Personal bankruptcy cases are filed under Chapter 7 or Chapter 13. In a Chapter 7 bankruptcy, you ask the court to discharge your debts. In exchange, you may have to turn over some of your assets. Chapter 7 is sometimes called a liquidation bankruptcy because a debtor's assets are liquidated (sold) to pay their creditors. 

The key players in a Chapter 7 bankruptcy case include:

• A debtor who files the petition for relief from their debt

• The debtor's creditors

• The bankruptcy trustee, a court-appointed official who oversees the management of the debtor's estate.

• A bankruptcy judge, who reviews the debtor's eligibility to file, rules on motions, and makes the final determination about discharge

When you file a Chapter 7 bankruptcy petition, you get an automatic stay. This is a temporary block on all collection efforts. During the automatic stay, your creditors can’t come after you for a debt, file a lawsuit against you, garnish your wages, or levy your bank account until your case is either dismissed or discharged. 

As part of the bankruptcy process, you'll attend a Section 341 meeting of creditors. At this meeting, the trustee will ask you questions about your debts and financial situation. Your creditors can also attend and ask questions. 

After the meeting of creditors, and after the court sells the things that you’re not allowed to keep (non-exempt assets), the trustee presents a final report to the court. The bankruptcy judge then decides whether to dismiss or discharge your case. Discharge means you're no longer responsible for the debts included in your bankruptcy petition.

Exempt vs. non-exempt assets in Chapter 7 bankruptcy

Filing Chapter 7 doesn't mean you have to give up everything you own. Some assets are exempt, which means you don't have to turn them over to the trustee. Examples of bankruptcy exemptions include:

• Federal benefit payments, like Social Security benefits or disability benefits

• Unemployment compensation

• Retirement accounts and pensions

• Child support and alimony payments you receive

• Tools of the trade you use for work

• Household goods

• Clothing

• A modest car

• Some home equity

The federal bankruptcy code lists allowed exemptions, and states have their own exemptions. In some states, you can choose to follow the federal list or the state list, whichever benefits you more.  

Chapter 7 bankruptcy means test

To be eligible for Chapter 7 bankruptcy, you have to pass a means test. This is a test to determine whether you have the means to repay all or some of your debts.

The means test has two parts. 

The first part measures your current monthly income, or your average monthly income for the six months before filing for bankruptcy protection. If your income is below the median income for your household size in your state, you're automatically eligible for Chapter 7. 

If your income is equal to or above the median, you'll have to complete the second part of the means test. This part looks at your expenses to determine whether you have enough disposable income to pay your debts. 

If your disposable income is below the allowed threshold, then you can file Chapter 7. If it's above the threshold and there are no special circumstances the court could consider, then you won't pass the means test. You can't file Chapter 7, but you could still file Chapter 13.