Understanding Chapter 7 Bankruptcy and Exemptions

Drowning in debt and overwhelmed by creditors? Chapter 7 bankruptcy might be a solution.

Drowning in debt and overwhelmed by creditors? Chapter 7 bankruptcy might be a solution. This blog post will break down the key aspects of Chapter 7 bankruptcy, providing a clear picture of how it works, what debts it can eliminate, and the impact it will have on your financial situation. How exemptions work and the role of the bankruptcy trustee will also be discussed. This way, you have a better understanding of the liquidation process, the protection it offers from creditors, and what kind of fresh start you can expect after filing.

Updated on December 4, 2024.

Updated on September 28, 2024.

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Key Points

• Chapter 7 is the most common type of bankruptcy
• Chapter 7 is known as a “liquidation.”
• The bankruptcy estate is created upon filing for bankruptcy and includes all assets that belong to the debtor.
• Exemptions protect a debtor’s assets.
• Any assets not exempt are sold by the bankruptcy trustee.
• To qualify for Chapter 7, a debtor has to pass the means test.

Chapter 7 Bankruptcy: The Liquidation Process

Chapter 7 is the most common type of bankruptcy filed, followed by Chapter 13. Chapter 7 is known as a “liquidation,” meaning that a petition filer might have to agree to sell some of their assets to approve their bankruptcy.  But in reality, in the majority of Chapter 7 cases, the debtor’s assets are exempt, meaning protected.

Exemptions: Protecting Your Assets in Chapter 7

While it is a common belief that if bankruptcy is filed, a debtor loses everything, but exemptions protect debtors. So, if an asset is exempt or protected, the debtor gets to keep it. So exempt assets are safe. However, exemptions vary per state, whether the type of asset is exempt or the protected amount. Let’s look at the state of Florida as an example.

In the state of Florida, the exemption for a car is listed in Florida Statute 222.25(1). The statute reads as follows:

Other individual property of natural persons is exempt from legal process.—The following property is exempt from attachment, garnishment, or other legal process:

(1) A debtor’s interest, not to exceed $1,000 in value, in a single motor vehicle as defined in s. 320.01.

So, filing for bankruptcy in Florida means a debtor has $1,000 in equity protected for their car. This is known as the Florida motor vehicle exemption. It can increase to $ 2,000, but it has to be a joint bankruptcy filing, meaning a married couple has filed together. Let’s use an example to explain exemptions better.

Suppose the debtor’s car is worth $5,000, and the car loan was paid off last year. With the $1,000 motor vehicle exemption, we subtract the $1,000 exemption from the $5,000, leaving $4,000 in equity, the non-exempt portion or the amount not protected.

What happens to that $4,000? That belongs to the bankruptcy estate.

Defining the Chapter 7 Bankruptcy Estate

The “bankruptcy estate” is simply all the assets that belong to the debtor. Once a petition is filed, all of the debtor’s property belongs to the estate, but from there, remember that we have to remove what is exempt.

• Avoid These Common Mistakes in Filing for Bankruptcy

When describing the bankruptcy estate to my students, I tell them to imagine a large pot where everything they own gets thrown inside. Then, the bankruptcy trustee starts removing what doesn’t belong in the pot because it is exempt. What remains in the pot belongs to the bankruptcy trustee.

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The Role of the Chapter 7 Bankruptcy Trustee

When a Chapter 7 petition is filed, a trustee is automatically assigned to the case. The trustee’s responsibility is to protect the bankruptcy estate. If there are assets that are not exempt, those assets belong to the bankruptcy estate, and it’s the trustee’s responsibility to sell those assets, and the money received will be distributed to the creditors.

Qualifying for Chapter 7: Passing the Means Test

It is common for me to hear from clients that they want to file Chapter 7 or 13. I always start those consultations by asking the client why Chapter 7. Usually, the answer is because they read online an article where they concluded with Chapter 7, they don’t have to pay anything back, unlike Chapter 13, where monthly payments are made to the trustee for the next three to five years. But to file Chapter 7, you must qualify. So, the first step in qualifying for Chapter 7 is passing the means test.

To qualify for Chapter 7, you must pass what’s called a means test. The means test was part of the changes made to bankruptcy law in 2005 with the Bankruptcy Abuse Prevention Consumer Protection Act (BAPCPA).

The means test can be complicated, but to explain it simply, your income is compared to the state median income. If your income is below the state average, you pass the means test and are one step closer to qualifying for Chapter 7. Now, notice I said one step closer and not necessarily qualifying automatically. Let me elaborate on that.

Let’s return to bankruptcy exemptions and the example used above, where your car had $4,000 in equity, the non-exempt portion of your bankruptcy estate. Even though you passed the means test, there is still this issue of how the $4000 will be handled. At this point, there are three options to consider.

What Happens to Non-Exempt Assets? Your Options.

Option 1

• The car is surrendered to the trustee who will sell it, and any funds received will be distributed to the creditors.

Option 2

• The trustee offers you the opportunity to buy your unexempt portion,  in this case $4000. U “// sually, trustees in a Chapter 7 case will allow for a payment plan of 10 to 12 months.

Option 3

• You cannot afford to pay back the trustee the $4000 in the next 10 to 12 months, but you want to keep your car, so at that point, you file for Chapter 13. To oversimplify for now, the Chapter 13 payment plan means that those $4000 are automatically paid to the bankruptcy trustee, sometimes known as the “standing trustee,” over the next 36 to 60 months.

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Please note that the information on this site does not constitute legal advice and should be considered for informational purposes only.