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Chapter 7 Bankruptcy Explained: Understanding the Basics for Individuals and Businesses

Chapter 7 bankruptcy, often referred to as “liquidation bankruptcy,” is a legal process that provides relief to individuals and businesses facing insurmountable debt.

By liquidating non-exempt assets, Chapter 7 allows debtors to eliminate most of their debts and make a fresh financial start.

At Berken Cloyes, we believe that understanding the basics of Chapter 7 bankruptcy is crucial for those considering this option.

Here is what Chapter 7 bankruptcy entails, who qualifies for it, the process involved, and the benefits and drawbacks for both individuals and businesses.

What is Chapter 7 Bankruptcy?

Chapter 7 bankruptcy is designed to provide debt relief by liquidating a debtor’s non-exempt assets to pay off creditors. Once the assets are sold, the proceeds are distributed to creditors, and most remaining debts are discharged, meaning the debtor is no longer legally obligated to pay them.

This type of bankruptcy is available to both individuals and businesses, although the outcomes and implications differ for each.

Who Qualifies for Chapter 7 Bankruptcy?

Eligibility for Chapter 7 bankruptcy is determined by the “means test,” which assesses whether the debtor’s income is low enough to qualify. The means test compares the debtor’s average monthly income over the past six months to the median income for their state.

If the income is below the median, the debtor is typically eligible for Chapter 7. If the income exceeds the median, further calculations are done to determine if the debtor has enough disposable income to repay some of the debts under a Chapter 13 repayment plan instead.

For businesses, there is no means test. Any business entity—corporations, partnerships, and sole proprietorships—can file for Chapter 7 if they are unable to pay their debts.

However, it’s important to note that a business filing for Chapter 7 will cease operations unless the trustee overseeing the case decides to continue them in order to liquidate assets.

The Chapter 7 Bankruptcy Process

  1. Filing the Petition – The process begins with the debtor filing a petition with the bankruptcy court. This petition includes detailed information about the debtor’s assets, liabilities, income, expenses, and financial history. For individuals, a certificate of credit counseling must also be filed.
  2. Automatic Stay – Upon filing, an automatic stay goes into effect immediately. This legal protection halts most collection activities, including lawsuits, wage garnishments, and harassing phone calls from creditors, providing the debtor with temporary relief.
  3. Appointment of a Trustee – A bankruptcy trustee is appointed to oversee the case. The trustee’s role includes reviewing the petition, identifying non-exempt assets, selling these assets, and distributing the proceeds to creditors.
  4. Meeting of Creditors – The debtor is required to attend a meeting of creditors (also known as a 341 meeting), where the trustee and creditors can ask questions about the debtor’s financial situation and the information provided in the bankruptcy petition.
  5. Liquidation of Assets – The trustee will liquidate (sell) the debtor’s non-exempt assets. Exempt assets, which vary by state but typically include necessities such as a primary residence, personal clothing, and a vehicle up to a certain value, are protected from liquidation.
  6. Distribution to Creditors – The proceeds from the liquidation are distributed to creditors in a specific order of priority, with secured creditors (those with collateral backing their loans) generally being paid first.
  7. Discharge of Debts – Once the assets are liquidated and the proceeds distributed, the court issues a discharge order, eliminating the debtor’s liability for most remaining unsecured debts, such as credit card balances, medical bills, and personal loans.
Benefits of Chapter 7 Bankruptcy

For Individuals:

  • Debt Relief: The primary benefit is the discharge of most unsecured debts, providing a fresh financial start.
  • Immediate Relief: The automatic stay provides immediate relief from collection efforts and creditor harassment.
  • Simplicity: The process is relatively quick, typically taking three to six months from start to finish.
  • No Repayment Plan: Unlike Chapter 13, there is no requirement to repay debts over a period of time.

For Businesses:

  • Debt Elimination: It allows businesses to eliminate their debts and close down operations in an orderly manner.
  • Simplified Process: The process of liquidation is straightforward, allowing for a quicker resolution compared to restructuring.
  • Protection from Creditors: The automatic stay protects the business from aggressive collection actions during the bankruptcy process.
Drawbacks of Chapter 7 Bankruptcy

For Individuals:

  • Asset Loss: Non-exempt assets are liquidated, which may include valuable property and personal items.
  • Credit Impact: A Chapter 7 bankruptcy stays on the debtor’s credit report for up to ten years, significantly impacting their credit score and ability to obtain new credit.
  • Not All Debts Discharged: Certain debts, such as student loans, alimony, child support, and some taxes, are not dischargeable under Chapter 7.

For Businesses:

  • Cessation of Operations: The business typically ceases operations and is dissolved.
  • Asset Liquidation: All business assets are sold off to pay creditors, which can include equipment, real estate, and intellectual property.
  • Impact on Stakeholders: Employees, shareholders, and other stakeholders may be adversely affected by the liquidation and closure of the business.

Chapter 7 bankruptcy offers a viable option for individuals and businesses overwhelmed by debt, providing a pathway to eliminate most debts and start anew. However, the decision to file for Chapter 7 should not be taken lightly, given the significant impact on assets, credit, and future financial opportunities.

At Berken Cloyes, we are committed to helping our clients understand their options and navigate the complexities of bankruptcy law.

If you are considering Chapter 7 bankruptcy, we encourage you to consult with our experienced team. We can provide personalized guidance and support to help you make informed decisions and achieve the best possible outcome for your financial future.

Contact Berken Cloyes today at 303-623-4357 to schedule a consultation and take the first step toward financial recovery.