Liquidation
Under the Bankruptcy Code
The chapter of the Bankruptcy Code providing for
 "liquidation,"
( i.e., the sale of a debtor's nonexempt property
and the distribution of the proceeds to creditors.)
a. Alternatives to Chapter 7
b. Background
c. Chapter 7 Eligibility
d. How Chapter 7 Works
e. Role of the Case Trustee
f. The Chapter 7 Discharge
Alternatives to
Chapter 7
Debtors should be aware that there are several
alternatives to chapter 7 relief. For example,
debtors who are engaged in business, including
corporations, partnerships, and sole proprietorships,
may prefer to remain in business and avoid liquidation.
Such debtors should consider filing a petition
under chapter 11 of the Bankruptcy Code. Under
chapter 11, the debtor may seek an adjustment
of debts, either by reducing the debt or by extending
the time for repayment, or may seek a more comprehensive
reorganization. Sole proprietorships may also
be eligible for relief under chapter 13 of the
Bankruptcy Code.
In addition, individual debtors who have regular
income may seek an adjustment of debts under chapter
13 of the Bankruptcy Code. A particular advantage
of chapter 13 is that it provides individual debtors
with an opportunity to save their homes from foreclosure
by allowing them to "catch up" past
due payments through a payment plan. Moreover,
the court may dismiss a chapter 7 case filed by
an individual whose debts are primarily consumer
rather than business debts if the court finds
that the granting of relief would be an abuse
of chapter 7. 11 U.S.C. § 707(b).
If the debtor's "current monthly income"(1)
is more than the state median, the Bankruptcy
Code requires application of a "means test"
to determine whether the chapter 7 filing is presumptively
abusive. Abuse is presumed if the debtor's aggregate
current monthly income over 5 years, net of certain
statutorily allowed expenses, is more than (i)
$10,950, or (ii) 25% of the debtor's nonpriority
unsecured debt, as long as that amount is at least
$6,575. (2) The debtor may rebut a presumption
of abuse only by a showing of special circumstances
that justify additional expenses or adjustments
of current monthly income. Unless the debtor overcomes
the presumption of abuse, the case will generally
be converted to chapter 13 (with the debtor's
consent) or will be dismissed. 11 U.S.C. §
707(b)(1).
Debtors should also be aware that out-of-court
agreements with creditors or debt counseling services
may provide an alternative to a bankruptcy filing.
Background
A chapter 7 bankruptcy case does not involve the
filing of a plan of repayment as in chapter 13.
Instead, the bankruptcy trustee gathers and sells
the debtor's nonexempt assets and uses the proceeds
of such assets to pay holders of claims (creditors)
in accordance with the provisions of the Bankruptcy
Code. Part of the debtor's property may be subject
to liens and mortgages that pledge the property
to other creditors. In addition, the Bankruptcy
Code will allow the debtor to keep certain "exempt"
property; but a trustee will liquidate the debtor's
remaining assets. Accordingly, potential debtors
should realize that the filing of a petition under
chapter 7 may result in the loss of property.
Chapter 7 Eligibility
To qualify for relief under chapter 7 of the Bankruptcy
Code, the debtor may be an individual, a partnership,
or a corporation or other business entity. 11
U.S.C. §§ 101(41), 109(b). Subject to
the means test described above for individual
debtors, relief is available under chapter 7 irrespective
of the amount of the debtor's debts or whether
the debtor is solvent or insolvent. An individual
cannot file under chapter 7 or any other chapter,
however, if during the preceding 180 days a prior
bankruptcy petition was dismissed due to the debtor's
willful failure to appear before the court or
comply with orders of the court, or the debtor
voluntarily dismissed the previous case after
creditors sought relief from the bankruptcy court
to recover property upon which they hold liens.
11 U.S.C. §§ 109(g), 362(d) and (e).
In addition, no individual may be a debtor under
chapter 7 or any chapter of the Bankruptcy Code
unless he or she has, within 180 days before filing,
received credit counseling from an approved credit
counseling agency either in an individual or group
briefing. 11 U.S.C. §§ 109, 111. There
are exceptions in emergency situations or where
the U.S. trustee (or bankruptcy administrator)
has determined that there are insufficient approved
agencies to provide the required counseling. If
a debt management plan is developed during required
credit counseling, it must be filed with the court.
One of the primary purposes of bankruptcy is to
discharge certain debts to give an honest individual
debtor a "fresh start." The debtor has
no liability for discharged debts. In a chapter
7 case, however, a discharge is only available
to individual debtors, not to partnerships or
corporations. 11 U.S.C. § 727(a)(1). Although
an individual chapter 7 case usually results in
a discharge of debts, the right to a discharge
is not absolute, and some types of debts are not
discharged. Moreover, a bankruptcy discharge does
not extinguish a lien on property.
How Chapter 7 Works
A chapter 7 case begins with the debtor filing
a petition with the bankruptcy court serving the
area where the individual lives or where the business
debtor is organized or has its principal place
of business or principal assets. (3) In addition
to the petition, the debtor must also file with
the court: (1) schedules of assets and liabilities;
(2) a schedule of current income and expenditures;
(3) a statement of financial affairs; and (4)
a schedule of executory contracts and unexpired
leases. Fed. R. Bankr. P. 1007(b). Debtors must
also provide the assigned case trustee with a
copy of the tax return or transcripts for the
most recent tax year as well as tax returns filed
during the case (including tax returns for prior
years that had not been filed when the case began).
11 U.S.C. § 521. Individual debtors with
primarily consumer debts have additional document
filing requirements. They must file: a certificate
of credit counseling and a copy of any debt repayment
plan developed through credit counseling; evidence
of payment from employers, if any, received 60
days before filing; a statement of monthly net
income and any anticipated increase in income
or expenses after filing; and a record of any
interest the debtor has in federal or state qualified
education or tuition accounts. Id. A husband and
wife may file a joint petition or individual petitions.
11 U.S.C. § 302(a). Even if filing jointly,
a husband and wife are subject to all the document
filing requirements of individual debtors. (The
Official Forms may be purchased at legal stationery
stores or downloaded from the internet at www.uscourts.gov/bkforms/index.html.
They are not available from the court.)
The courts must charge a $245 case filing fee,
a $39 miscellaneous administrative fee, and a
$15 trustee surcharge. Normally, the fees must
be paid to the clerk of the court upon filing.
With the court's permission, however, individual
debtors may pay in installments. 28 U.S.C. §
1930(a); Fed. R. Bankr. P. 1006(b); Bankruptcy
Court Miscellaneous Fee Schedule, Item 8. The
number of installments is limited to four, and
the debtor must make the final installment no
later than 120 days after filing the petition.
Fed. R. Bankr. P. 1006. For cause shown, the court
may extend the time of any installment, provided
that the last installment is paid not later than
180 days after filing the petition. Id. The debtor
may also pay the $39 administrative fee and the
$15 trustee surcharge in installments. If a joint
petition is filed, only one filing fee, one administrative
fee, and one trustee surcharge are charged. Debtors
should be aware that failure to pay these fees
may result in dismissal of the case. 11 U.S.C.
§ 707(a).
If the debtor's income is less than 150% of the
poverty level (as defined in the Bankruptcy Code),
and the debtor is unable to pay the chapter 7
fees even in installments, the court may waive
the requirement that the fees be paid. 28 U.S.C.
§ 1930(f).
In order to complete the Official Bankruptcy Forms
that make up the petition, statement of financial
affairs, and schedules, the debtor must provide
the following information:
1. A list of all creditors and the amount and
nature of their claims;
2. The source, amount, and frequency of the debtor's
income;
3. A list of all of the debtor's property; and
4. A detailed list of the debtor's monthly living
expenses, i.e., food, clothing, shelter, utilities,
taxes, transportation, medicine, etc.
Married individuals must gather this information
for their spouse regardless of whether they are
filing a joint petition, separate individual petitions,
or even if only one spouse is filing. In a situation
where only one spouse files, the income and expenses
of the non-filing spouse is required so that the
court, the trustee and creditors can evaluate
the household's financial position.
Among the schedules that an individual debtor
will file is a schedule of "exempt"
property. The Bankruptcy Code allows an individual
debtor (4) to protect some property from the claims
of creditors because it is exempt under federal
bankruptcy law or under the laws of the debtor's
home state. 11 U.S.C. § 522(b). Many states
have taken advantage of a provision in the Bankruptcy
Code that permits each state to adopt its own
exemption law in place of the federal exemptions.
In other jurisdictions, the individual debtor
has the option of choosing between a federal package
of exemptions or the exemptions available under
state law. Thus, whether certain property is exempt
and may be kept by the debtor is often a question
of state law. The debtor should consult an attorney
to determine the exemptions available in the state
where the debtor lives.
Filing a petition under chapter 7 "automatically
stays" (stops) most collection actions against
the debtor or the debtor's property. 11 U.S.C.
§ 362. But filing the petition does not stay
certain types of actions listed under 11 U.S.C.
§ 362(b), and the stay may be effective only
for a short time in some situations. The stay
arises by operation of law and requires no judicial
action. As long as the stay is in effect, creditors
generally may not initiate or continue lawsuits,
wage garnishments, or even telephone calls demanding
payments. The bankruptcy clerk gives notice of
the bankruptcy case to all creditors whose names
and addresses are provided by the debtor.
Between 20 and 40 days after the petition is filed,
the case trustee (described below) will hold a
meeting of creditors. If the U.S. trustee or bankruptcy
administrator (5) schedules the meeting at a place
that does not have regular U.S. trustee or bankruptcy
administrator staffing, the meeting may be held
no more than 60 days after the order for relief.
Fed. R. Bankr. P. 2003(a). During this meeting,
the trustee puts the debtor under oath, and both
the trustee and creditors may ask questions. The
debtor must attend the meeting and answer questions
regarding the debtor's financial affairs and property.
11 U.S.C. § 343. If a husband and wife have
filed a joint petition, they both must attend
the creditors' meeting and answer questions. Within
10 days of the creditors' meeting, the U.S. trustee
will report to the court whether the case should
be presumed to be an abuse under the means test
described in 11 U.S.C. § 704(b).
It is important for the debtor to cooperate with
the trustee and to provide any financial records
or documents that the trustee requests. The Bankruptcy
Code requires the trustee to ask the debtor questions
at the meeting of creditors to ensure that the
debtor is aware of the potential consequences
of seeking a discharge in bankruptcy such as the
effect on credit history, the ability to file
a petition under a different chapter, the effect
of receiving a discharge, and the effect of reaffirming
a debt. Some trustees provide written information
on these topics at or before the meeting to ensure
that the debtor is aware of this information.
In order to preserve their independent judgment,
bankruptcy judges are prohibited from attending
the meeting of creditors. 11 U.S.C. § 341(c).
In order to accord the debtor complete relief,
the Bankruptcy Code allows the debtor to convert
a chapter 7 case to case under chapter 11, 12
or 13 (6) as long as the debtor is eligible to
be a debtor under the new chapter. However, a
condition of the debtor's voluntary conversion
is that the case has not previously been converted
to chapter 7 from another chapter. 11 U.S.C. §
706(a). Thus, the debtor will not be permitted
to convert the case repeatedly from one chapter
to another.
Role of the Case
Trustee
When a chapter 7 petition is filed, the U.S. trustee
(or the bankruptcy court in Alabama and North
Carolina) appoints an impartial case trustee to
administer the case and liquidate the debtor's
nonexempt assets. 11 U.S.C. §§ 701,
704. If all the debtor's assets are exempt or
subject to valid liens, the trustee will normally
file a "no asset" report with the court,
and there will be no distribution to unsecured
creditors. Most chapter 7 cases involving individual
debtors are no asset cases. But if the case appears
to be an "asset" case at the outset,
unsecured creditors (7) must file their claims
with the court within 90 days after the first
date set for the meeting of creditors. Fed. R.
Bankr. P. 3002(c). A governmental unit, however,
has 180 days from the date the case is filed to
file a claim. 11 U.S.C. § 502(b)(9). In the
typical no asset chapter 7 case, there is no need
for creditors to file proofs of claim because
there will be no distribution. If the trustee
later recovers assets for distribution to unsecured
creditors, the Bankruptcy Court will provide notice
to creditors and will allow additional time to
file proofs of claim. Although a secured creditor
does not need to file a proof of claim in a chapter
7 case to preserve its security interest or lien,
there may be other reasons to file a claim. A
creditor in a chapter 7 case who has a lien on
the debtor's property should consult an attorney
for advice.
Commencement of a bankruptcy case creates an "estate."
The estate technically becomes the temporary legal
owner of all the debtor's property. It consists
of all legal or equitable interests of the debtor
in property as of the commencement of the case,
including property owned or held by another person
if the debtor has an interest in the property.
Generally speaking, the debtor's creditors are
paid from nonexempt property of the estate.
The primary role of a chapter 7 trustee in an
asset case is to liquidate the debtor's nonexempt
assets in a manner that maximizes the return to
the debtor's unsecured creditors. The trustee
accomplishes this by selling the debtor's property
if it is free and clear of liens (as long as the
property is not exempt) or if it is worth more
than any security interest or lien attached to
the property and any exemption that the debtor
holds in the property. The trustee may also attempt
to recover money or property under the trustee's
"avoiding powers." The trustee's avoiding
powers include the power to: set aside preferential
transfers made to creditors within 90 days before
the petition; undo security interests and other
prepetition transfers of property that were not
properly perfected under nonbankruptcy law at
the time of the petition; and pursue nonbankruptcy
claims such as fraudulent conveyance and bulk
transfer remedies available under state law. In
addition, if the debtor is a business, the bankruptcy
court may authorize the trustee to operate the
business for a limited period of time, if such
operation will benefit creditors and enhance the
liquidation of the estate. 11 U.S.C. § 721.
Section 726 of the Bankruptcy Code governs the
distribution of the property of the estate. Under
§ 726, there are six classes of claims; and
each class must be paid in full before the next
lower class is paid anything. The debtor is only
paid if all other classes of claims have been
paid in full. Accordingly, the debtor is not particularly
interested in the trustee's disposition of the
estate assets, except with respect to the payment
of those debts which for some reason are not dischargeable
in the bankruptcy case. The individual debtor's
primary concerns in a chapter 7 case are to retain
exempt property and to receive a discharge that
covers as many debts as possible.
The Chapter 7 Discharge
A discharge releases individual debtors from personal
liability for most debts and prevents the creditors
owed those debts from taking any collection actions
against the debtor. Because a chapter 7 discharge
is subject to many exceptions, though, debtors
should consult competent legal counsel before
filing to discuss the scope of the discharge.
Generally, excluding cases that are dismissed
or converted, individual debtors receive a discharge
in more than 99 percent of chapter 7 cases. In
most cases, unless a party in interest files a
complaint objecting to the discharge or a motion
to extend the time to object, the bankruptcy court
will issue a discharge order relatively early
in the case – generally, 60 to 90 days after
the date first set for the meeting of creditors.
Fed. R. Bankr. P. 4004(c).
The grounds for denying an individual debtor a
discharge in a chapter 7 case are narrow and are
construed against the moving party. Among other
reasons, the court may deny the debtor a discharge
if it finds that the debtor: failed to keep or
produce adequate books or financial records; failed
to explain satisfactorily any loss of assets;
committed a bankruptcy crime such as perjury;
failed to obey a lawful order of the bankruptcy
court; fraudulently transferred, concealed, or
destroyed property that would have become property
of the estate; or failed to complete an approved
instructional course concerning financial management.
11 U.S.C. § 727; Fed. R. Bankr. P. 4005.
Secured creditors may retain some rights to seize
property securing an underlying debt even after
a discharge is granted. Depending on individual
circumstances, if a debtor wishes to keep certain
secured property (such as an automobile), he or
she may decide to "reaffirm" the debt.
A reaffirmation is an agreement between the debtor
and the creditor that the debtor will remain liable
and will pay all or a portion of the money owed,
even though the debt would otherwise be discharged
in the bankruptcy. In return, the creditor promises
that it will not repossess or take back the automobile
or other property so long as the debtor continues
to pay the debt.
If the debtor decides to reaffirm a debt, he or
she must do so before the discharge is entered.
The debtor must sign a written reaffirmation agreement
and file it with the court. 11 U.S.C. § 524(c).
The Bankruptcy Code requires that reaffirmation
agreements contain an extensive set of disclosures
described in 11 U.S.C. § 524(k). Among other
things, the disclosures must advise the debtor
of the amount of the debt being reaffirmed and
how it is calculated and that reaffirmation means
that the debtor's personal liability for that
debt will not be discharged in the bankruptcy.
The disclosures also require the debtor to sign
and file a statement of his or her current income
and expenses which shows that the balance of income
paying expenses is sufficient to pay the reaffirmed
debt. If the balance is not enough to pay the
debt to be reaffirmed, there is a presumption
of undue hardship, and the court may decide not
to approve the reaffirmation agreement. Unless
the debtor is represented by an attorney, the
bankruptcy judge must approve the reaffirmation
agreement.
If the debtor was represented by an attorney in
connection with the reaffirmation agreement, the
attorney must certify in writing that he or she
advised the debtor of the legal effect and consequences
of the agreement, including a default under the
agreement. The attorney must also certify that
the debtor was fully informed and voluntarily
made the agreement and that reaffirmation of the
debt will not create an undue hardship for the
debtor or the debtor's dependants. 11 U.S.C. §
524(k). The Bankruptcy Code requires a reaffirmation
hearing if the debtor has not been represented
by an attorney during the negotiating of the agreement,
or if the court disapproves the reaffirmation
agreement.11 U.S.C. § 524(d) and (m). The
debtor may repay any debt voluntarily, however,
whether or not a reaffirmation agreement exists.
11 U.S.C. § 524(f).
An individual receives a discharge for most of
his or her debts in a chapter 7 bankruptcy case.
A creditor may no longer initiate or continue
any legal or other action against the debtor to
collect a discharged debt. But not all of an individual's
debts are discharged in chapter 7. Debts not discharged
include debts for alimony and child support, certain
taxes, debts for certain educational benefit overpayments
or loans made or guaranteed by a governmental
unit, debts for willful and malicious injury by
the debtor to another entity or to the property
of another entity, debts for death or personal
injury caused by the debtor's operation of a motor
vehicle while the debtor was intoxicated from
alcohol or other substances, and debts for certain
criminal restitution orders.11 U.S.C. § 523(a).
The debtor will continue to be liable for these
types of debts to the extent that they are not
paid in the chapter 7 case. Debts for money or
property obtained by false pretenses, debts for
fraud or defalcation while acting in a fiduciary
capacity, and debts for willful and malicious
injury by the debtor to another entity or to the
property of another entity will be discharged
unless a creditor timely files and prevails in
an action to have such debts declared nondischargeable.
11 U.S.C. § 523(c); Fed. R. Bankr. P. 4007(c).
The court may revoke a chapter 7 discharge on
the request of the trustee, a creditor, or the
U.S. trustee if the discharge was obtained through
fraud by the debtor, if the debtor acquired property
that is property of the estate and knowingly and
fraudulently failed to report the acquisition
of such property or to surrender the property
to the trustee, or if the debtor (without a satisfactory
explanation) makes a material misstatement or
fails to provide documents or other information
in connection with an audit of the debtor's case.
11 U.S.C. § 727(d).
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NOTES
1. The "current monthly income" received by the debtor is a defined term in the Bankruptcy Code and means the average monthly income received over the six calendar months before commencement of the bankruptcy case, including regular contributions to household expenses from nondebtors and including income from the debtor's spouse if the petition is a joint petition, but not including social security income or certain payments made because the debtor is the victim of certain crimes. 11 U.S.C. § 101(10A). return to text
2. To determine whether a presumption of abuse arises, all individual debtors with primarily consumer debts who file a chapter 7 case must complete Official Bankruptcy Form B22A, entitled "Statement of Current Monthly Income and Means Test Calculation - For Use in Chapter 7." (The Official Forms may be purchased at legal stationery stores or downloaded from the internet at www.uscourts.gov/bkforms/index.html. They are not available from the court.) return to text
3. An involuntary chapter 7 case may be commenced under certain circumstances by a petition filed by creditors holding claims against the debtor. 11 U.S.C. § 303. return to text
4. Each debtor in a joint case (both husband and wife) can claim exemptions under the federal bankruptcy laws. 11 U.S.C. § 522(m). return to text
5. In North Carolina and Alabama, bankruptcy administrators perform similar functions that U.S. trustees perform in the remaining 48 states. These duties include establishing a panel of private trustees to serve as trustees in chapter 7 cases and supervising the administration of cases and trustees in cases under chapters 7, 11, 12, and 13 of the Bankruptcy Code. The bankruptcy administrator program is administered by the Administrative Office of the United States Courts, while the U.S. trustee program is administered by the Department of Justice. For purposes of this publication, references to U.S. trustees are also applicable to bankruptcy administrators. return to text
6. A fee is charged for converting, on request of the debtor, a case under chapter 7 to a case under chapter 11. The fee charged is the difference between the filing fee for a chapter 7 and the filing fee for a chapter 11. 28 U.S.C. § 1930(a). Currently, the difference is $755. Id. There is no fee for converting from chapter 7 to chapter 13. return to text
7. Unsecured debts generally may be defined as those for which the extension of credit was based purely upon an evaluation by the creditor of the debtor's ability to pay, as opposed to secured debts, for which the extension of credit was based upon the creditor's right to seize collateral on default, in addition to the debtor's ability to pay. return to text
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