Personal Bankruptcy

Individuals may pursue two types of bankruptcy under the Bankruptcy Code: Chapter 7 and Chapter 13.

Chapter 7

Chapter 7 bankruptcy, also called liquidation bankruptcy, involves liquidating (selling) a debtor’s non-exempt assets and using the proceeds to repay creditors. An individual must meet specific eligibility requirements to file for Chapter 7. Most importantly, an individual must pass the “means test,” which examines whether a debtor can afford to repay their debts under another form of bankruptcy.

The first step of the means test checks whether a debtor’s average monthly income falls below the median income in the debtor’s state. If a debt fails the first step, the test deducts allowable expenses from the debtor’s average monthly income to determine whether their disposable income (the difference between monthly income and expenses) can afford to repay the debtor’s debts.

When a person files for Chapter 7, the court imposes an automatic stay that bars the individual’s creditors from starting or continuing debt collection efforts, such as making debt collection phone calls, sending debt collection letters, repossessing assets, foreclosing on property, or filing collection lawsuits. A creditor who wishes to commence or continue debt collection efforts against a debtor must petition the bankruptcy court for relief from the automatic stay.

After filing the bankruptcy petition, the case trustee appointed by the bankruptcy court will hold a meeting of creditors at which the debtor must answer questions about their financial affairs and assets and acknowledge they understand the consequences of pursuing a Chapter 7 bankruptcy petition. The consequences include the effect on credit history, the ability to seek bankruptcy under another chapter, or the consequences of receiving a discharge.

The case trustee administering the debtor’s bankruptcy will gather and liquidate (sell) the debtor’s non-exempt assets and use the proceeds to repay the debtor’s creditors as bankruptcy law requires. A debtor may exempt certain assets listed under state law from liquidation, including:

• A certain amount of equity in a primary residence
• Vehicles and tools used in business
• Certain personal property
• Public benefits
• Workers’ compensation benefits
• Life insurance proceeds
• Tax-exempt retirement accounts

Once the trustee liquidates the debtor’s non-exempt assets and pays creditors, the debtor will receive a discharge of most remaining debts, meaning the debtor no longer has an obligation to repay those discharged debts. However, a bankruptcy court cannot discharge some debts, including alimony, child support, certain taxes, student loans, loans guaranteed by a government agency, or specific criminal restitution orders.

Chapter 13

A Chapter 13 bankruptcy, also called a wage earner’s bankruptcy, allows a debtor to repay outstanding debts in installments over a three- to five-year period. An applicant may file for Chapter 13 if they have unsecured debts of less than $526,700 and secured debts of less than $1,580,125. When an individual files for Chapter 13 bankruptcy, the bankruptcy court will impose an automatic stay.

A Chapter 13 bankruptcy case proceeds under a repayment plan that a debtor files with the bankruptcy court for approval. A debtor keeps all their assets in Chapter 13. Instead, the debtor makes periodic fixed payments to the case trustee as the repayment plan requires. The trustee then distributes those funds to the debtor’s creditors as the plan outlines.

A repayment plan can offer creditors less than full payment on their claims, though it must pay priority creditors (debts granted special status under bankruptcy law) in full unless the creditor agrees to a different treatment of their claim. Debtors may also use the repayment plan to catch up on arrearages for some types of secured debts. Otherwise, the debtor must provide a secured creditor with the value of the collateral or the full amount owed on the debt. A plan does not have to provide full payment to unsecured creditors if the debtor pays all their disposable income during the plan and the unsecured creditors receive at least as much as they would have in a Chapter 7 bankruptcy.

A debtor in a Chapter 13 case may receive a discharge of qualifying outstanding debts upon completing the repayment plan if the debtor has:

• Paid all domestic support obligations
• Not received a Chapter 13 discharge in the past two years or a Chapter 7 discharge in the past four years
• Completed an approved financial management course

A debtor who cannot complete their repayment plan can petition the bankruptcy court for a hardship discharge if their failure to complete the plan occurred due to circumstances outside their control.