Every now and again you have business owners and individuals who find themselves so overwhelmed with debt that the only way out is to file for bankruptcy. When a company or individual reaches this point, they have amassed so much debt that their current income levels are not sufficient to even make the minimum required payments. In such a case, bankruptcy is often the only way to find some relief. In the United States, bankruptcies continue to rise at an annual rate between 5% and 8%.
Chapter 7 bankruptcy is one of six different filing types a business or individual can choose when initiating the proceedings. It takes its name from the chapter of U.S. code in which it's found. The other five types are known as chapters 11, 12, 13, 9, and 15. Chapter 9 is for municipalities; chapter 15 is for cross-border proceedings; chapter 12 is reserved for family farms and fishing operations. Of the remaining three types, chapter 7 is used most often for personal bankruptcies and sole proprietorship liquidations.
How does Chapter 7 bankruptcy work?
Since Chapter 7 bankruptcy is more or less a total liquidation, the individual or business surrenders all of its non-exempt assets to the court. The bankruptcy court will sell off those assets and use the money to pay off creditors. If all creditors can't be satisfied, those who aren't must bear the losses on their own unless they believe they can win a separate civil lawsuit against the individual or business owners. Such lawsuits are rarely filed.
The one saving grace to the rules governing a Chapter 7 bankruptcy is the fact that there are some assets which are exempt from seizure. For example, a court cannot seize a home that is your primary residence in order to pay off creditors. The individual filing for bankruptcy must still be allowed to maintain some semblance of normal life as he works through the bankruptcy proceeding. If the court seized assets to the point where the individual was left homeless or unable to work a job, he would never have hope of recovery.
What counts as non-exempt assets for a business depends on how the business was organized to begin with. If the business is a sole proprietorship its filing is treated as a personal bankruptcy with all the rules applied accordingly. If a business is organized as a partnership, corporation, or LLC, the personal assets of any owners or officers are off the table. Any assets needed to make payments on non-dischargeable debts are also off limits. Other than that, there's not much left that can't be seized by the court.
Who is eligible to file a Chapter 7 bankruptcy?
Individuals and sole proprietors are almost always eligible for this form of bankruptcy because they are treated as personal filings rather than business filings. Beyond that, certain types of businesses are also eligible for Chapter 7 depending on their current circumstances and debt load. Regardless of whether the filer is an individual or a business however, there are certain criteria that must be met in order to use Chapter 7.
The first of two main criteria is known as the "means test." The means test takes into consideration the total debt load, current income streams, and cost of living expenses. If a court deems that an individual has sufficient means to pay off debts after the means test has been applied, he will not be able to file under Chapter 7. Instead, he will have to go Chapter 13. A corporation, partnership, or LLC that "fails" the means test will be forced into Chapter 11. Both Chapters 11 and 13 are considered reorganization rather than liquidation.
The other important criteria rest with whether or not the individual or company has had any other previous bankruptcy discharges. In most cases, neither an individual nor a business will be eligible for Chapter 7 bankruptcy if they have had a previous bankruptcy discharge within the last 6 to 8 years. All of the criteria used to measure Chapter 7 eligibility is intended to prevent individuals or companies from using it as a quick way to wipe out all their debts.
Is there anything else I need to know?
Before you are allowed to file Chapter 7 bankruptcy there are some things that are required by law. First of all, individuals filing under this chapter must undergo counseling with an approved credit counseling agency. Part of that counseling is to educate consumers on debt management and financial choices. Secondly, you must have exhausted all other possibilities - including a debt settlement service.
A debt settlement service helps consumers regain control of their debt by contacting creditors to work out payment plans and helping clients come up with a reasonable plan to repay all the debt. A court wants to see that individuals filing Chapter 7 have exhausted all other opportunities before coming to them. Like the other eligibility requirements previously mentioned, the idea behind this is to prevent people from simply writing off their debts because they don't want to pay them.
The last thing you need to know has to do with real estate and how it applies to bankruptcy. As we previously stated, the home that you use as your primary residence cannot be seized and sold in order to appease creditors. However, it is still possible for you to be foreclosed on, after the bankruptcy proceeding is complete, if you have not kept your mortgage current. The same also applies to your primary vehicle. Therefore, it's important for you to keep all current debts paid on time during the entire bankruptcy proceeding, so that you don't lose them after the process is complete.