What is Chapter 7 bankruptcy and how does it work?

US law has six different types of bankruptcy, each catering to different circumstances and entities seeking relief from debt.

In Chapter 7 bankruptcy, a debtor’s non-exempt assets are liquidated, meaning they are sold by a court-appointed trustee. The proceeds from the sale are then used to repay creditors as fully as possible. This is what people may consider bankruptcy when they hear the word; nearly everything which isn’t nailed to the floor is sold to pay for debts.

However, certain assets may be exempt from liquidation, such as a primary residence, a vehicle, and essential personal belongings, depending on the specific exemptions allowed by state or federal law.

Chapter 7 bankruptcy can provide individuals or businesses with a fresh start by wiping out overwhelming debt. However, it also has significant consequences, including the loss of non-exempt assets.

Filing for Chapter 7 bankruptcy

To file for Chapter 7 bankruptcy, the debtor must pass a means test, which compares their income to the median income in their state. The purpose of the means test is to determine if the debtor has enough disposable income to repay their debts partially or in full. If the debtor’s income is below the state median or they don’t have enough disposable income, they typically qualify for Chapter 7.

Once the bankruptcy petition is filed, an automatic stay goes into effect, stopping most collection actions by creditors. The court then appoints a trustee to oversee the case. The trustee’s role is to gather the debtor’s non-exempt assets, sell them, and distribute the proceeds to creditors.

At the end of the bankruptcy process, the debtor receives a discharge, which is a court order that eliminates personal liability for most types of debts. Certain debts, such as student loans, child support, and some taxes, are typically not dischargeable.