Quick Guide to the Basics: Liquidation, Exemptions, and The Means Test

A Breakdown on Chapter 7 Bankruptcy and the Liquidation Test

In my practice and as a professor of bankruptcy law, I often see clients make key assumptions about Chapter 7 and Chapter 13 that could put their assets at risk. This quick guide breaks down the core concepts I discussed in my video, giving you the essential information you need before you file.

By Alexander Hernandez, J.D., Professor, and Author of Consumer Bankruptcy Law (Routledge).

Updated on October 3, 2025.

Listen: The Professor’s Audio Briefing.

What is “Liquidation,” and Do I Lose Everything in Chapter 7?

Chapter 7 bankruptcy is sometimes referred to as a “liquidation bankruptcy,” but that term is misleading in most consumer cases.

• The Reality: The vast majority of Chapter 7 cases are “no-asset” cases, meaning the debtor gets a discharge without losing any property.
• The Rule: Liquidation is the legal process where the court-appointed Trustee sells your non-exempt assets to pay your creditors.
• The Protection: The fact that most people keep all their property is thanks to exemptions.

How Do Exemptions Work, and Why Do They Matter Most?

Exemptions are the core legal tool that shields your assets from the bankruptcy trustee.

• The Key Difference: Exemptions (which vary state by state) allow you to protect a specific dollar amount of equity in certain assets, such as your home, car, and personal property. You can learn more about the exemptions in your state at the bottom of the page, where there are links to “Find Your Local Bankruptcy Court.”
• Case Example (Florida Motor Vehicle Exemption): A debtor can exempt $5,000 of equity in their car. If they have $8,000 of equity, the remaining $3,000 is non-exempt and theoretically at risk of liquidation unless the debtor pays back $3,000.
• Keep in Mind: Determining your non-exempt equity is the first, most crucial step in any bankruptcy filing.

Chapter 7 vs. Chapter 13: A Temporary Stay vs. A Permanent Fix

Debtors often mistake the automatic stay in Chapter 7 for a permanent solution, particularly when they are behind on secured debts.

Chapter 7 (Liquidation)	Chapter 13 (Reorganization)
Temporary Stop: The automatic stay prevents creditors from repossessing or foreclosing, but only for a short time.	Permanent Fix: Allows you to structure a repayment plan to catch up on missed payments (arrearages) on your home or vehicle over 3-5 years.
Secured Debt: Cannot save a car or house if you are behind on payments; the property must be surrendered or redeemed.	Secured Debt: Can potentially “cram down” car loans or strip certain secondary mortgages.

If your primary goal is to save a secured asset where you are behind on payments, Chapter 13 is the only legal option.

Protecting Social Security Income in Bankruptcy

Means Testing: The Most Common Mistake Debtors Make

Qualifying for Chapter 7 hinges on the Means Test, and this is where self-represented debtors often make their biggest error.

• The Standard: To pass the Means Test, your average income over the last six months must be below the median income for a family of your size in your state.
• The Mistake: Many debtors believe that passing the income threshold automatically qualifies them for Chapter 7. This is false!
• The Second Step (Disposable Income): The Means Test also calculates your disposable income based on your necessary expenses (listed on Schedule I). If your income is high enough to make significant payments to creditors, the Trustee can argue you should file a Chapter 13, even if your income is technically below the state median.

Final Advice from the Professor

The decision to file Chapter 7 or Chapter 13 is highly complex. It involves calculating the Means Test (income) versus expenses, Exemptions (assets), and the Liquidation Test (minimum repayment). It’s my recommendation to always consult with qualified bankruptcy lawyers first, as many offer flexible payment plans.

Colleges and universities can purchase my bankruptcy law textbook directly from Routledge Publishing. Paralegals and students who are buying single copies can do so via Amazon Books. To access my YouTube channel, click this link. You can also listen to my podcast on Spotify.

You can learn more about filing for bankruptcy and the bankruptcy petition via this link. Information on the bankruptcy court system, contact information for trustees, and your state’s exemptions can be found here. The federal bankruptcy exemptions are listed here. The latest version of the 341 Meeting of the Creditors can be found here.

You can find additional categories by clicking below or by using the search feature at the top of this page:

• Bankruptcy
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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.

Updated initially on December 16, 2024.