Bankruptcy laws in the United States allow individuals and corporations to get out of debt, either by selling off a debtor's assets and repaying creditors (i.e., liquidation) or by undergoing a court-supervised reorganization of the debtor's finances. Filing for bankruptcy allows individuals to extinguish many unsecured debts, although a record of an individual's bankruptcy filing stays on his or her credit report for 10 years.
The Bankruptcy Code sets forth several paths for individuals and businesses to emerge from debt. Each route is contained within a chapter of the law. Chapter 7 provides a process for liquidating d debtor's assets, the proceeds of which are used to pay back creditors. Chapter 7 bankruptcy allows an individual or business to retain some property that is exempt under the law, but most assets are sold, or liquidated, to pay off creditors.
Although many of an individual's unsecured debts will be cancelled after a Chapter 7 filing, some will remain. Chapter 7 doesn't wipe out many types of debt, such as most student loan debts, child support obligations, some taxes, and fines owed for crimes committed by the debtor. Most liens, including a real estate mortgage, also remain despite a bankruptcy filing. Under Chapter 7, there is no discharge, or cancellation, of debts for corporations or partnerships.
The process of filing for Chapter 7 bankruptcy in the U.S. changed extensively when the federal Bankruptcy Abuse Prevention and Consumer Protection Act (BAPCPA) went into effect on October 17, 2005. Congress enacted BAPCPA to prevent abuses of the bankruptcy laws, creating the most sweeping changes to bankruptcy laws since 1978. Individuals filing for Chapter 7 bankruptcy now must wait longer between bankruptcy filings, and are subject to means testing to determine whether a debtor is abusing the process. BAPCPA added credit counseling and financial education requirements, and provides debtors with fewer protection from collection activities. Fewer debts can now be discharged with a Chapter 7 filing.
Who may file for Chapter 7 Bankruptcy?
A business that is unable to service its debt or pay its creditors can voluntarily file—or sometimes be forced by its creditors to file—for bankruptcy in a federal court under Chapter 7. When a business files for Chapter 7 bankruptcy, it stops operating and a court-appointed Chapter 7 Trustee sells all of its assets, distributing the funds to creditors. Creditors with a security interest are paid before unsecured creditors.
Individuals can also file for Chapter 7 bankruptcy, and in fact Chapter 7 bankruptcy is most commonly used by individuals who can no longer pay creditors. An individual cannot file for Chapter 7 bankruptcy if he or she already did so in the previous 180 days and the bankruptcy petition was dismissed, or that individual failed to appear or comply with the court's orders, or the debtor dismissed the case voluntarily but after his or her creditors with liens sought the help of the court to recover property. If an individual has had debts discharged in a Chapter 7 bankruptcy, that person must wait more than eight years—up from the previous six year limitation before BAPCPA—to have debts discharged by a Chapter 7 filing.
An individual also must complete credit counseling with an approved agency in the 180 days prior to filing for Chapter 7 bankruptcy, unless the court grants a waiver. The law also now requires that all individuals in either Chapter 7 bankruptcy complete an "instructional course concerning personal financial management." If the debtor doesn't complete the course, the court can refuse to discharge his or her debts.
An individual also may not be able to file for Chapter 7 bankruptcy if the U.S. Trustee challenges the filing as abusive. If an individual has enough disposable income that he or she can pay all or some outstanding debts over five years, the U.S. Trustee may not allow those debts to be discharged under Chapter 7 bankruptcy. Instead, the individual may have to file for Chapter 13 bankruptcy, which is a reorganization bankruptcy whereby an individual pays creditors back over three to five years under a court-approved repayment plan.
A court may find a Chapter 7 bankruptcy filing to be abusive if the court determines from all circumstances that the debtor is acting in bad faith or if the court finds that the debtor has sufficient funds to repay his or her debts under the means test imposed by BAPCPA.
The means test, found at 11 U.S.C. §707(b)(2), compares the debtor's current monthly income—actually an average of six months of income—to the median income in the debtor's state. If the debtor's income is greater than the median, then a "means test" designed to figure out just how much a debtor could repay creditors applies. The means test requires that the debtor subtract living expenses specified in the statute from his or her current monthly income. The revised current monthly income figure will then be considered to determine whether the debtor does in fact have enough money to repay creditors. If that figure reaches certain levels specified in BAPCPA, a presumption of abuse applies that a debtor will either have to overcome or have his or her case dismissed.
Once a debtor files a Chapter 7 petition, the court will impose an automatic stay. This means that collection activities must stop (with some exceptions) and creditors must seek relief from the bankruptcy court instead of the debtor. BAPCPA limited the protections the stay provides in some re-filed cases and made it harder for persons facing eviction to use a Chapter 7 filing to avoid being evicted. The law also added strict new rules for debtors to alert creditors that the stay is in effect, and protects creditors from having to pay monetary penalties for violating the stay if the debtor did not give "effective" notice as required by the statute.