Apr 17

Bankruptcy Basics: Chapter 7

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Chapter 7

by Brett Bodie

The bankruptcy code is found in Title 11 of the United States Code (Title 11 is the bankruptcy code). The code is the basis for every rule and power that exists in bankruptcy.

The code contains chapters which each address different ways of filing bankruptcy. “Chapter 7” refers to the portion of the bankruptcy code beginning with 11 U.S.C §701. A Chapter 7 case is known as a “Liquidation” bankruptcy. When Congress passed the Bankruptcy Reform Act of 1978 and created modern the modern Chapter 7, they wanted to create a system where people could file bankruptcy and obtain relief from their creditors. They also wanted the system to efficiently distribute the benefit of the Debtors’ assets to their creditors. This where the term “liquidation” comes from.

Congress understood, however, that even Debtors in bankruptcy could not be left destitute and so they provided for “exemptions” that the Debtors are entitled to. Exemptions are laws which allow the Debtors to claim safe certain items in bankruptcy. Exemption statutes can be federal or state based, depending upon the specific residence or domicilary history of the Debtors. Here in Encino, Ca where I practice (part of the San Fernando Valley – a suburb of Los Angeles) we have state exemptions that are used by most Debtors. There are two statutory schemes, California Code of Civil Procedure §704 and California Code of Civil Procedure §703. A Debtor who uses the California exemption scheme cannot “mix and match” exemptions, but must elect either elect to use either California Code of Civil Procedure §703 or California Code of Civil Procedure §704.

Exemptions are powerful – despite being called a “liquidation” case, in most Chapter 7 cases nothing is liquidated. In fact, as many as 94% of cases filed under chapter 7 are “no asset” cases.

A Chapter 7 case begins with the Debtor (or Debtors if filed Jointly) first completing a credit counseling course. A case can almost never be successfully filed without the Debtors having previously completed a credit counseling course. The next step is filing a bankruptcy petition asking the bankruptcy Court to grant them relief under bankruptcy. Upon filing of a bankruptcy case, an estate is created. All property that the Debtors own or have an interest in (and some property they may no longer have, depending on various issues that can arise), becomes part of the bankruptcy estate.

This may sound disconcerting, but for almost all cases (remember about 94% of them), nothing important changes for the Debtors. The creation of the bankruptcy estate is to allow a Bankruptcy Trustee to liquidate any assets that are not exempt. If all the Debtors’ assets are exempt, then the estate will close when the Debtors’ bankruptcy case is closed.

A Bankruptcy Trustee is a private fiduciary appointed to oversee and administer a bankruptcy estate. Although the Trustee is appointed by the office of the United States Trustee, the individual Bankruptcy Trustee is not a government employee. Bankruptcy Trustees are often bankruptcy attorneys, accountants or other experts in receivership who have been chosen for their knowledge and expertise.

The office of the United States Trustee (known as the “UST”) is part of the United States Department of Justice. The UST’s role is to oversee the administration of bankruptcy cases. In a consumer Chapter 7 bankruptcy case, the UST’s primary role is to be a “watchdog” that enforces many of the rules in bankruptcy. The UST employes analysts, paralegals and attorneys who watch for fraud, perjury, abuse (including by creditors) or other malicious conduct. The UST does not bring criminal cases on its own, but it does refer criminal cases for prosecution by the United States Attorney’s office. The UST also has a duty to review all Chapter 7 bankruptcy filings for “abuse.”

In 2005, Congress passed the Bankruptcy Abuse Prevention and Consumer Protection Act (BAPCPA). BAPCPA introduced significant changes to the Bankruptcy system including the inclusion of the “Means Test.” The Means Test is a test that tries to set an objective standard for whether Debtors have (or rather, should have, not that they actually do) so much disposable income that it would be “abuse” for them not to at least partially repay their creditors in a Chapter 13 case.

The Means Test is complex but a simplified version is this: The first step compares the Debtors average income in the six months preceding the case to the median income for a household of similar size for the area in which the Debtors live. If the Debtors are below the median income for their household size, they “pass” the Means Test (meaning it is presumed that their filing is not “abuse”). If the Debtors are above the median income for their household size they do not automatically “fail” the Means Test, they simply go on to part two. For example, here in Los Angeles, Ca the median income for a single person for the Chapter 7 bankruptcy Means Test is $48,415.00 or $4,035.00 per month. So, if you were single and lived in the greater Los Angeles area and earned over $4,035.00 per month, then you would go to step two of the Means Test.

The second part of the Means Test takes the Debtors’ average household income and then deducts a hybrid of expenses. Most of the expenses are allowance expenses from tables provided by the UST (they are not the Debtors’ actual expenses). A few of the Debtors’ actual expenses can be used. At the end of the second step to the means test, Debtors may have negative disposable income or disposable income below the threshold to be considered “abuse.” If this is the case, then they still “pass” the Means Test (meaning their filing is not presumed to be and “abuse”). If the Debtors’ disposable income is above the “abuse” threshold, then a rebuttable presumption arises that their case is an “abuse.” Debtors can successfully rebut a presumption of abuse and still remain in Chapter 7 but they generally will have a more complex case and will have to do a significant amount of work to overcome the objections of the UST. This is just a general overview of the Means Test which is significantly more complex than what is discussed above.

Assuming the Debtors “pass” the Means Test and are presumed not to be an abuse, the next step in their bankruptcy case is attending the Meeting of Creditors. The Meeting of Creditors location is assigned based on the jurisdiction the Debtors filed in (which should be based on the recent residence history of the Debtors). If you lived in any part of the San Fernando Valley for example (such as Woodland Hills, Encino, Van Nuys, etc..) then you would be assigned to attend your Meeting of Creditors at the Woodland Hills UST location (21051 Warner Center Lane #115 Woodland Hills, Ca 91367). Many times the UST will use a location that is not a Bankruptcy Courthouse (such as the Woodland Hills, Ca location above), but rather a private space rented by the UST and used to conduct the Meeting of Creditors

Despite the name, for most Debtors, there will not be any creditors present. The Bankruptcy Trustee is acting for the benefit of all creditors and in most cases the Trustee is the only party who will question the Debtors at the Meeting of Creditors. At the Meeting of Creditors, Debtors will be called to appear before the Bankruptcy Trustee. They are required to testify under oath. Every Trustee has their own unique questions they may ask, and many questions are tailored to the Debtors’ individual case. The Trustee will have reviewed the Debtors’ bankruptcy petition, schedules and forms prior to the meeting and will have an idea of the Debtors’ financial situation ahead of time. In many cases, the Trustee may only ask a “normal” set of questions. If the Trustee has seen something in the papers, or if something arises during the meeting, they may ask many additional questions. For many Trustees, the initial Meeting of Creditors allows them to isolate the vast majority of cases where there are clearly no assets to distribute, nor defects that must be addressed, from the few cases where there may be significant issues. If there are issues the Trustee needs to look into further, they will often continue the Meeting of Creditors. In such a case it is common for the Trustee to request additional documentation and possibly amendments to the Debtors’ schedules. In cases with significant issues, the Trustee may request a Rule 2004 examination (essentially a deposition) where they can perform an in depth inquiry into the Debtors’ case.

Assuming all goes well at the Meeting of Creditors, it concludes and the Debtors do not have to return. The conclusion of the meeting can end with a few different results. In the vast majority of cases, the Meeting of Creditors will conclude and within a few days the Bankruptcy Trustee will file a a Report of No Distribution. Depending upon the jurisdiction, this item may be described differently (it may be called a “No Asset” Report or other similar names). Whatever the name, it is a report by the Bankruptcy Trustee which states that there are no assets of the Debtors which are not exempt (it means there is nothing the Debtors own that the Trustee intends to liquidate for the benefit of creditors). If the Debtors may have assets that the Trustee is investigating, the Trustee will instead file an “Initial Report” which tells the creditors and other parties in interest that there is a possibility that the Trustee may recover assets in the case. Normally, unless there is a notification by the Trustee that there are assets to administer, creditors will not file Proofs of Claim in a Chapter 7 case. Upon notification by the Trustee of assets that may be recovered, the Court will set a Claims Bar Date (a deadline to file proofs of claim, normally 90 days from the conclusion of the Meeting of Creditors. Governmental creditors are given additional time.) Proofs of Claim are exactly what they sound like – formal statements filed by creditors which state the amounts owed to them and the basis for their claim against the Debtor. Proofs of Claim can be objected to by the Debtor or the Trustee if either party believe there is a reason to do so. Sometimes, a Trustee is unsure whether there will be any tangible asset recovery for creditors. In such a case, the Trustee will file an Initial Report that indicates to creditors and other parties that there may be an asset to distribute. In many cases, the Trustee may end up concluding the case without actual recovery. In a few cases (again, about 6% of the time) there will be un-exempt assets that can be liquidated for the benefit of creditors. The Trustee is entitled to statutory fees and costs and often incurs significant professional expenses (in most cases, the Trustee has to hire lawyers and accountants to recover assets) that are usually also deducted from any recovery. Any payment to the Trustee or professionals they hire is done so with the permission of the Bankruptcy Court Judge who oversees the distribution of any asset liquidated for creditors. Often times, there are scenarios where a Trustee may wish to abandon specific assets. They do so through a Notice of Proposed Abandonment (or similar name depending upon jurisdiction). Often, Debtors get a copy of a Notice of Abandonment for large items such as real estate and are confused about the meaning – not to worry, it is a formal notice that the Trustee has no interest in the item described therein.

After the Meeting of Creditors, there are usually very few things for the Debtors to do. The Debtors may need to finish completing Reaffirmation Agreements (agreements to remain personally liable on secured debts. To read more about them click here), or to complete their Financial Management Course (2nd Credit Counseling).

After 60 days have passed from the conclusion of the Meeting of Creditors, the Debtors will be eligible for discharge. The 60 days allows time for creditors and other parties in interest to file objections to the dischargeability of their particular claims, or objections to the discharge in general. Objections to discharge are relatively rare, although “junk-debt” discharge objections are unfortunately becoming more commonplace.

Once the Debtors receive their Discharge Order, the case will normally conclude soon thereafter (assuming there are no assets or other issue to keep the case administratively open).