Chapter 7 bankruptcy protection: When financial issues hit a breaking point

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It’s a drastic step for dire financial circumstances.

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When financial issues become so overwhelming that it looks like there’s no way out, a chapter 7 bankruptcy filing might be the answer. As far as bankruptcies are concerned, it’s considered a quick and relatively efficient way to get rid of eligible debts—a reset, of sorts. But “eligible” is a key word here, and the process is open only to those in the direst of straits.

The U.S. Bankruptcy Code emphatically points out that a chapter 7 filing “provides for ‘liquidation’—the sale of a debtor’s nonexempt property and the distribution of the proceeds to creditors.” In other words, it can be a total wipeout of much of what you own and cherish. The same is true for companies that choose to file chapter 7. There are some instances in which assets can be saved, but that’s the exception, not the rule.

Unlike a chapter 13 bankruptcy filing, there is no repayment plan opportunity with chapter 7. It’s a liquidation, and the debtor can lose their nonexempt assets, such as vacation properties, extra cars, jewelry, and so on. If your car and house payments are current, you may get to keep those assets, especially if you don’t have much equity in them.

This bankruptcy alternative is available to individuals, partnerships or corporations, and other business entities. However, individual and business chapter 7 filings will take slightly different paths.

Individuals must pass a means test, which compares the filer’s income to the median income of the state where they live. If their income is below that level in the previous six months, the filer is considered eligible.

If not, a second step requires the debtor to put together a thorough list of how much money is spent on day-to-day living, such as for housing, food, clothing, medicines, and the like. These are considered nondiscretionary expenses. Discretionary expenses, such as money spent on dining out, vacations, unnecessary clothing, and jewelry, for example, will be carefully scrutinized because it means you’re buying things you can live without rather than paying off debts.

Businesses do not have to pass a means test, because their chapter 7 filing is typically already a means to an end: liquidating the entire enterprise.

Although chapter 7 bankruptcy can offer a fresh start, it doesn’t clean all the debt books. Not everything is dischargeable, such as:

This is ultimately a do-or-die game for those who have what Debt.org calls “crippling or insurmountable financial problems.” Yes, you must give up plenty of whatever is left in your personal property arsenal, but if you don’t, you’re not likely to recover from the mounting debt. That can lead to bigger problems—personally, professionally, and legally.

Before filing a petition with the bankruptcy court in their jurisdiction, individuals have to undergo credit counseling. And before the petition is discharged, you’ll have to take a financial management course.

A credit counselor might be able to offer you an alternative route that isn’t liquidation. Besides, once you’re out of bankruptcy, the courts don’t want you to make the same financial mistakes that landed you there.

When filing with the court in your jurisdiction, you also must file:

Plus, the court requires:

Those whose liabilities are heavy in consumer debt, such as credit card or retail debt, have additional filing requirements, according to the U.S. Bankruptcy Code:

As with all bankruptcy types, you’ll need money to file, including a $245 case filing fee; a $78 miscellaneous administrative fee; and a $15 trustee surcharge. In some cases, installment payments may be allowed. In other cases, such as if the debtor’s income is 150% under the poverty level and they are unable to cover the fees, they may be waived.

Remember, too, there are credit counseling costs—and attorney fees, if you choose to use one.

Unlike a lengthy chapter 11 or chapter 13 bankruptcy filing, a chapter 7 should only take four to six months to get through. That’s one reason why it’s the most widely used form of bankruptcy.

Assuming the petition is accepted, the court will order an automatic “stay,” which essentially stops all creditors from moving forward with collection actions against the individual, the business, or their property. That means no lawsuits, wage garnishments, or even harassing telephone calls.

Once the case begins, an “estate” is created as a means of liquidating the debtor’s property and giving the proceeds to secured creditors first. However, not all property is considered “free and clear” in a chapter 7 filing. Although this is a liquidation process, individuals won’t necessarily lose everything they own. That’s where the “exempt” and “nonexempt” designations for property come into play. Remember, the purpose of any individual bankruptcy is to help you find better financial footing to reset your life.

Exempt property varies from state to state. But according to FindLaw.com, exempt property generally includes what individuals need for day-to-day living:

As with every other bankruptcy chapter, individuals are barred from filing for protection again if at any time during the preceding six months, or 180 days, a bankruptcy was dismissed because they didn’t show up or follow the rules. Bankruptcy does allow for second chances, but only once, and not if you shirked your responsibilities the first time around.

Chapter 7 bankruptcy is usually reserved for those with “crippling or insurmountable financial problems.” In other words, consider any other options for getting your finances back in order, such as a debt settlement with your biggest creditors. There also are a bevy of financial management services out there, such as nonprofit debt management or debt counseling companies.