Chapter 7 Bankruptcy
Chapter 7 of the Bankruptcy Code is available to individuals, partnerships and corporations. 11 U.S.C. § 109(b). The purpose of chapter 7 is to provide the honest individual debtor with a “fresh start” by discharging most, if not all, of the debtor’s debts. A chapter 7 discharge is available only to individuals and not to partnerships or corporations. 11 U.S.C. § 727(a)(1). Although most individual chapter 7 cases result in a discharge of all debts, some types of debts are not discharged (i.e. student loans and certain taxes). Moreover, some individual chapter 7 bankruptcy cases run the risk of dismissal if the Office of the United State’s Trustee believes the debtor’s net disposable income is sufficient to fund a chapter 13 plan.
The Chapter 7 Process
A chapter 7 bankruptcy case begins with the filing of a petition for relief pursuant to the United States Bankruptcy Code (the “bankruptcy petition”). 11 U.S.C. § 301(a). The bankruptcy petition is filed with the Bankruptcy Court in the district where the individual lives or where the business debtor has its principal place of business or its principal assets. The debtor, in addition to the bankruptcy petition, must also file schedules listing all assets and all debts, an income and expense report, and a statement of financial affairs. Federal Rules of Bankruptcy Procedure 1007(b). Married persons may file a joint bankruptcy petition or one or both spouses may file individual bankruptcy petitions. 11 U.S.C. § 302(a). Joint petitioners pay only one filing fee.
Once a bankruptcy case is filed, most creditor actions against the debtor and the debtor’s property are enjoined pursuant to the “automatic stay” provisions of the Bankruptcy Code. 11 U.S.C. § 362(a). This stay arises by operation of law and requires no additional judicial action. While the stay is in effect, creditors cannot initiate or continue lawsuits, repossessions, or wage garnishments.
While Chapter 7 of the Bankruptcy Code is often referred to as a liquidation or a “straight bankruptcy,” Chapter 7 debtors will rarely lose any assets. Most, if not all of a Chapter 7 debtor’s assets are exempt under federal bankruptcy exemption laws and/or the laws of the state where the debtor resides (In your case, the Texas exemption laws). Married persons may only claim one set of exemptions
Shortly after the filing of a chapter 7 bankruptcy case a bankruptcy trustee is appointed. 11 U.S.C. §§ 701, 702. The trustee’s duties are to examine and verify the accuracy of the debtor’s bankruptcy papers and to identify assets which are not exempt. 11 U.S.C. § 704. The trustee sells the non-exempt assets which have value and distributes the net proceeds to the debtor’s creditors. To the extent an asset has a lien against it (i.e. a car or a house) such asset has value only to the extent the debt against the asset when combined with the amount of any exemption is less than the fair market value of the asset. 11 U.S.C. §§ 506, 522.
A “meeting of creditors” (the “341(a) hearing“) is held about 30 days after the bankruptcy petition is filed. 11 U.S.C. § 341(a). The debtor must attend this meeting, and if a husband and wife filed jointly, both must attend. Creditors may appear and ask questions regarding the debtor’s financial affairs and property, but creditors rarely attend. The meeting is conducted by the chapter 7 trustee and not the bankruptcy judge. The debtor testifies under penalty of perjury and must cooperate with the chapter 7 trustee. Any debtor that fails to cooperate with the chapter 7 trustee or to testify truthfully could be denied a discharge. 11 U.S.C. §§ 502, 727; Federal Rules of Bankruptcy Procedure 4004.
The Bankruptcy Court Clerk issues the discharge, approximately 75 days after the first date set for the 341 hearing. See generally, Federal Rules of Bankruptcy Procedure 4004. A copy of the discharge is mailed to the debtor and all the creditors listed in the debtor’s schedules.
The Chapter 7 Trustee
As mentioned supra a chapter 7 trustee is appointed to administer the bankruptcy estate and liquidate the debtor’s non-exempt assets. In most cases, all of the debtor’s assets are exempt or subject to valid liens, so a trustee usually has no assets to sell. Chapter 7 bankruptcy cases with no non-exempt assets are commonly referred to as “no asset” cases. If the debtor has non-exempt assets or if the trustee later recovers assets to liquidate for distribution to unsecured creditors, the creditors are given an opportunity to file a form stating the basis of their claim against the debtor’s bankruptcy estate.
As intimated above, the filing of a bankruptcy petition creates an “estate,” and the trustee becomes the temporary legal owner of the debtor’s property. 11 U.S.C. § 541. The bankruptcy estate consists of all the debtor’s legal or equitable interest in property, including property owned or held by another person. 11 U.S.C. § 541. By way of example, the bankruptcy estate includes, tax refunds, law suits, insurance claims, and any intellectual property rights.
The chapter 7 trustee is required to analyze the value of each and everyone of the debtor’s assets. The trustee will consider the fair market value of the asset, any claim of exemption, as well as any liens recorded against the asset. The trustee reserves the right to object to the extent and validity of any lien as well as any claim of exemption. Objections to the debtor’s exemptions must be filed within 30 days of the conclusion of the 341 hearing. Federal Rules of Bankruptcy Procedure 4003.
A bankruptcy discharge releases the debtor from personal liability and prevents the creditors from taking any further action against the debtor or his property to collect the debts. 11 U.S.C. §§ 523, 727. Creditors are afforded the right to either object to the discharge of their particular debt or object to the debtor’s discharge. 11 U.S.C. §§ 523, 727. A creditor may pursue one or both of these remedies by filing a complaint with the bankruptcy court.
Absent an extension by court order, a creditor has 60 days to commence an adversary proceeding objecting to the debtor’s discharge. Federal Rules of Bankruptcy Procedure 4004. The grounds for objecting to a bankruptcy discharge in a chapter 7 are narrow, and the creditor or trustee objecting to the discharge has the burden of proving the case. 11 U.S.C. § 727. In general, the grounds for denial of a discharge are: (1) the debtor has failed to keep and produce adequate financial records; (2) the debtor has failed to explain satisfactorily a loss of assets; (3) the debtor committed a bankruptcy crime; (4) the debtor failed to obey a lawful order of the bankruptcy court; or (5) the debtor fraudulently transferred, concealed, or destroyed property that, but for the improper transfer, would have been property of the estate. 11 U.S.C. § 727.
Once a discharge is granted, the trustee, a creditor, or the U.S. Trustee may later file a complaint to revoke a chapter 7 discharge if they can prove: (1) the discharge was obtained through the fraud of the debtor; or (2) the debtor acquired property that is property of the estate and knowingly and fraudulently failed to report the acquisition of such property or to surrender the property to the trustee. 11 U.S.C. § 727(d). Generally, this complaint must be filed within a year after the discharge was granted. 11 U.S.C. § 727(e).
Certain types of debts may not be discharged in a chapter 7 such as alimony and child support, most taxes, student loans made or guaranteed by a governmental unit, debts for death or personal injury caused by the debtor’s operation of a motor vehicle while intoxicated from alcohol or other substances, and debts for criminal restitution orders. 11 U.S.C. § 523. To the extent that these types of debts are not fully paid in the chapter 7 case, the debtor is still responsible for them after the bankruptcy.
A creditor’s claim for money or property obtained by false pretenses, debts for fraud while acting in a fiduciary capacity, debts for willful and malicious injury to another or to the property of another, and debts arising from a property settlement agreement incurred during or in connection with a divorce will be discharged unless the creditor timely files an adversary complaint. 11 U.S.C. § 523. The deadline for a creditor to commence an adversary proceeding objecting to the discharge of such debts is 60 days from the first date set for the creditors meeting. Federal Rules of Bankruptcy Procedure 4007. The presumption is in favor of the discharge, and the creditor normally has the burden of proof to show that such debts should be excepted from the bankruptcy discharge.
The Secured Creditor
Secured creditors are creditors that have a valid and perfected lien against one or more of the debtor’s assets. Secured creditors normally retain their lien rights (including the right to repossess or foreclose) regardless of any discharge issued by the bankruptcy court. The debtor must decide whether to retain or surrender such assets. If a debtor returns the collateral, and a discharge is granted, the debtor will no longer be liable to that secured creditor.
However, a debtor wishing to retain property that is collateral for a creditors, (i.e. cars and homes) may “reaffirm” the debt or redeem the property. A reaffirmation agreement between the debtor and the creditor creates a new contract between the respective parties where the debtor promises to pay all or a portion of the money owed. The reaffirmation agreement causes the debtor to once again become personally liable to the secured creditor. The reaffirmed debt will survive the discharge. In return, the creditor promises as long as payments are made, the creditor will not repossess the automobile or other property. If the debtor defaults on the payments, the creditor may repossess and sell the collateral. And if the sale price is not enough to satisfy the debt, the debtor will the creditor any deficiency. Note that Texas, unlike California, does not permit a debtor to allow the secured creditor’s lien to simply “ride through” the bankruptcy process absent reaffirmation or redemption. Johnson v. Sun Fin. Co. (In re Johnson), 89 F.3d 249 (5th Cir. 1996) (per curiam) (no retention of collateral without reaffirmation or redemption).
A debtor may redeem an asset by paying the fair market value in a lump sum. For example, if the balance on a car loan is $10,000 but the car is only worth $7,000, it may be sensible to redeem the car. From a practical perspective most debtors that file bankruptcy do not have access to ready cash sufficient to pay the secured creditor. There are, however, companies that will provide redemption financing. While their interest rates are high, it may still be the preferred course of action depending on how negotiations relative to reaffirmation proceed.