Mention bankruptcy and many people will blurt out "Chapter 7." It is the best known of the bankruptcy chapters, but how exactly does it work? I'm glad you asked.
What is Chapter 7? It is a reference to a part of the bankruptcy code. The code is arranged in chapters. Other common bankruptcy chapters you might be familiar with include Chapter 11 and Chapter 13. Chapter 11 is for businesses that wish to reorganize their finances. Airlines file Chapter 11 bankruptcy all the time. Chapter 13 is the equivalent of the reorganization idea, but for individuals instead of businesses.
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Chapter 7 works in a relatively straight forward manner. There is no effort to reorganize the debts of the debtor. Instead, the assets of the debtor are gathered by a trustee. The trustee then liquidates all non-exempt assets and distributes the funds to the creditors. The creditors receive the funds in order of their priority. The priority is established by code with secured creditors [car lender] getting paid before unsecured creditors [credit cards]. Before this happens, however, you have to prove you are eligible to proceed with a Chapter 7 bankruptcy filing.
You have to be eligible to file bankruptcy? Yes you do if you want to file under Chapter 7. You can thank President Bush and the Republican controlled congress a few years back. The Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 added a dozy of a test to the Chapter 7 filing. It is known as the "means test". It is a subject for an entire article on its own, so make sure to discuss it with your attorney.
Assuming you are eligible, the steps of a Chapter 7 filing are very simple. You will start off by filing a petition for bankruptcy with the court. Part and parcel to the petition will be a number of schedules listing all your debts and assets, who you owe money, your overall financial situation and any leases and contracts you have signed. Your tax return will also be required for the most recent year. If you are filing primarily because of credit card debt, you'll also be required to take a credit counseling consultation and come up with a potential repayment plan.
Once the bankruptcy starts moving forward, there are additional filings that must be made. As an individual, you will have to file schedules listing all your creditors, what you owe them and why; your sources of income and the amounts for each; a list of all the property you own; and a detailed profile of your monthly living expenses. This allows the trustee to evaluate your living situation. You will also be required to file a list of exempt property.
About 30 to 60 days after filing for bankruptcy, the trustee for the case will call a creditor meeting. The trustee will put you under oath in the courtroom. The trustee and creditors may then ask you question about your financial situation, assets and so on. A week or two after that, the trustee will report to the court on the case, whether it should remain a Chapter 7 filing and, if so, whether a discharge should occur. The trustee will then move to liquidate the non-exempt assets of the debtor, pay the revenues out to the creditors and then close the case with a discharge in which the debtor is freed of their debts.
The bankruptcy case is not a high drama legal action like you see on television. It is mostly a matter of moving paper around, and hardly anything to get excessively worked up over.
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