Chapter 7 Liquidation Bankruptcy

Most cases filed in the United States are Chapter 7 liquidation cases. Chapter 7 is available to both corporations and individuals. When an individual debtor files a Chapter 7 case, he turns over all nonexempt assets to a bankruptcy trustee, who sells them and distributes them to creditors according to a structured priority scheme.

Issues may arise in a Chapter 7 where the trustee could disagree with the creditor over what property is exempt and challenge the value of the debtor’s exempt property as too low. The trustee or creditors could also object to a debtor’s discharge due to wrongdoing of the debtor right before or during the bankruptcy case (if the debtor hid assets, for example). In most cases though, a Chapter 7 trustee administers the case within 90 days of the filing, there is no litigation, and after these 90 days are over, the debtor obtains a discharge of most of his or her debts.

Exemptions

Exempt property is property that the debtor can claim value in out of the estate under the Bankruptcy Code or state law. The federal and state exemption schemes allow debtors to keep enough assets to survive, and some provide for much more than that. In Chapter 7 cases, the exemptions determine which property the debtor can keep and which assets must instead be given to the trustee for sale and distribution of the proceeds to creditors. In a Chapter 13, the debtor will generally not need to sell nonexempt assets. Instead, the exemption calculations will be used to determine the minimum amount the debtor must distribute under the plan to unsecured creditors. Most Chapter 11 cases are business reorganizations, and because corporations and LLCs are not entitled to exemptions , the exemptions usually play no part in a Chapter 11.

All jurisdictions have state exemptions that can be used in bankruptcy. Some states allow a debtor to choose between state and federal exemptions. Notable federal exemptions include: (1) Homestead and personal property that a debtor uses as a residence, including a mobile home, up to $18,450; (2) debtor’s interest in one motor vehicle, up to $2,950; (3) debtor’s interest in household goods, furnishings, clothing, musical instruments, etc, up to $475 per item, $9,850 total; (4) jewelry held by debtor or dependent of the debtor, up to $1,225. There are many more exemptions listed in the Code. Married couples may double all of the federal exemptions to get a doubled limit. Florida has an unlimited homestead exemption, meaning that if a debtor had a $10 million dollar home that is paid off, he could file for bankruptcy and keep the entire house.

Claims & Distributions

Creditors must first file a proof of claim. The claim must be filed in a timely manner. If not, the claims may be allowed by the court but are subordinated to those creditors who have filed on time. A claim is allowed unless a party in interest objects. Disputed claims are rare. The starting point for analyzing claims treatment under the Code is to determine whether a claim is secured or unsecured. Secured claims are treated very differently from unsecured claims in bankruptcy. A secured creditor has a lien or some kind of interest in property of the debtor that gives the creditor a direct claim in the assets. Unsecured creditors’ claims are not secured by assets of the debtor.

Unsecured claims: The Bankruptcy Code says that unsecured creditors get: (1) Principal; (2) Pre-petition interest; and (3) Pre-petition attorney’s fees. Unsecured creditors are not entitled to payment on post-petition interest or attorney’s fees.

Secured Claims: The first thing to determine is whether the secured creditor is oversecured or undersecured. Oversecured is when the debt is less than the value of the collateral. Undersecured is when the debt exceeds the value of the collateral. Undersecured creditors have a claim that is bifurcated, separated into 2 different portions. Portion one is an allowed secured claim that is equal to the value of the collateral. Portion two, the allowed unsecured claim, is equal to the difference between the debt and the value of the collateral. Undersecured creditors can also claim pre-petition interest and attorney’s fees, but not post-petition. Oversecured creditors fare better b/c their claim is not bifurcated. They get pre and post-petition interest and attorney’s fees if they have an agreement that provides for such an entitlement.

Distributions to Creditors: Secured creditors will get paid first. Unsecured creditors are separated into different priority classes. Priority unsecured creditors such as: administrative expense creditors, trustee’s fees, insurance, taxing authorities, domestic support obligations, are paid first. Each priority class gets paid in full or to its dollar limit before the next class gets paid anything. This sets up an incentive on priority creditors to scrutinize those ahead of them. Regular unsecured creditors are paid last, if there is anything left. The debtor is relieved from all remaining pre-petition debts once the claims are paid.

Discharge

The bankruptcy discharge frees the debtor from legal obligations to pay discharged pre-petition debts, and creditors are forever barred from collecting those discharged debts because the Code contains permanent injunction against collection. There is a strong prohibition against attempts to collect on discharged debts. Creditors must understand the legal implications of the Code.

In Chapter 7, discharge happens automatically at the end of the case (usually 90 days from filing). In a Chapter 13, the debtor usually does not receive a discharge until he has completed all plan payments or obligations (usually 3-5 years). In a Chapter 11case, most debts are discharged upon confirmation or approval of the plan, not upon completion of all plan payments. Generally, only pre-petition debts are discharged. Also to be discharged the debt must have arisen to the level of a claim described broadly in the Code

Not all debts get discharged. Hiding assets and lying are reasons to deny a discharge, as are making a fraudulent transfer right before the case, not keeping records, and losing money without an explanation. Some debts are excepted from discharge because society thinks that people should be obligated to pay no matter what. These include: alimony, child support, debts for recent taxes, debts for criminal restitution claims, DUI claims, and student loans.

Post Bankruptcy: Redemption & Reaffirmation

Bankruptcy discharge voids judgments. If a creditor has a judgment against a debtor based on a pre-petition debt and is discharged, then it is void. There are some options for consumer debtors, post-bankruptcy when dealing with secured debt:

Reaffirmation is a way that debtors can reaffirm a secured debt (basically reinstitute & render enforceable a debt that would be discharged

Redemption allows the debtor to exercise a right of redemption. A debtor may hold on to property by paying the value of the collateral in a lump sum payment

Retention-De Facto is where the parties agree to themselves to hold on to property and keep making scheduled payments like before the bankruptcy

Dismissal

The means test of the code has been amended to provide for dismissal of a Chapter 7 case or conversion to a Chapter 13 upon finding of abuse by an individual debtor. Abuse can be found in 1 of 2 ways: (1) through an un-rebuttable presumptions of abuse arising under the means test; (2) on general grounds of bad faith. The means test says that if a debtor who files for Chapter 7 and is an above median debtor in that state and has at least $166.67 ($10K for 5 yrs) in current monthly income available after allowed deductions, then abuse is presumed regardless of the amount of the debtor’s unsecured debt. If the debtor has at least $100 a month of such income ($6000 for 5 years) abuse is presumed if income is sufficient to pay at least 25% of debtor’s unsecured debt over 5 years. This test is predicated on the belief that abuse of the bankruptcy system is pervasive. It is designed to discourage consumers from filing bankruptcy in the first place by increasing cost and complexity of filing.