Patrick O'Malley

Chapter 7 Bankruptcy Definition - Liquidation

Simplified overview

Chapter 7 is what most people think of when they hear the word bankruptcy—a consumer overwhelmed with debt and facing wage garnishments and a car repossession. Chapter 7 is a ‘liquidation’ bankruptcy. In a Chapter 7 case, the filer (who is usually an individual or a married couple, but a stand-alone business can also file) must give up all their assets, except those assets that are ‘exempt’. The exempt assets include things like equity in a home and cars, retirement accounts, household goods, and professional and personal items. The court trustee sells the non-exempt assets and uses the money to pay the creditors according to a specific priority system. Once the money is paid out, the filer is no longer liable for most debts. The filer is not required to pay anything to those former creditors in the future, even though the creditors did not get repaid the full amount of the debt. Note, that certain debts are never discharged. Alimony, child support and most taxes are common types of unsecured debt that cannot be discharged in Chapter 7. But, they will be paid first, before the unsecured claims like medical and credit card bills. Secured debt like a mortgage or car loan is not discharged, bankruptcy or not. Secured debts either have to be paid back, or the property is given to the creditor.

Two examples of typical Chapter 7 cases.

Chapter 7 for an individual -

Filer Fred had a health problem that was not fully covered by insurance. In addition to significant uninsured medical costs, he was not able to earn income from his regular job. Credit card debts grew bigger and he fell behind on mortgage payments, support payments, and taxes.

Faced with no realistic option for paying back all the debts, Frank talks to a bankruptcy lawyer. They first determine that Frank passes the means test; his income is low enough that he can use Chapter 7. Next, they determine that almost all of Frank’s debts can be discharged in Chapter 7.

Then, they inventory his non-exempt assets: a time-share, a boat, a coin and stamp collection, and a gun collection. These will all be sold by the court trustee.

Then, they inventory Frank’s potentially exempt assets: a retirement account, a home, a car, a motorcycle, gunsmithing tools he uses in his side job, clothing, and furniture. A certain dollar amount of each of these categories will be exempt from the trustee. In Frank’s case his various categories are all below that threshold dollar amount. Frank and his lawyer determine that he has significant equity in his home so it makes sense for him to get current on his mortgage. His equity dollar amount is below the homestead exemption threshold, so the trustee will not be able to sell the house.

The trustee sells the non-exempt assets and pays the creditors, starting with the tax bill and support obligations. If those are not fully paid off, then Frank will still owe the balance on those, even after bankruptcy. Frank is cleared of all the medical and credit card debt.

Chapter 7 for businesses -

Chapter 7 when a business is involved can be just as simple as a Chapter 7 for an individual. Or it can be much more complex. It all depends on the facts.

The main issue is whether the business owner is personally liable for debts of the business. Landlords, lenders and other creditors know all about bankruptcy law, so normally they require a small business owner to personally guarantee business debts and contracts. Additional complications may arise if there are multiple owners. With those caveats in mind, let’s look at a very simple and fairly common scenario.

Fred is the sole owner of a restaurant. During the stay at home orders he switched to take out, but it simply wasn’t enough to cover costs. Foot traffic was not going to increase fast enough. His personal finances aren’t great. But, if it wasn’t for his restaurant debts and contracts, he would not need to declare bankruptcy. If he wanted to save the business he would reorganize under Chapter 11 or Chapter 13. Instead, he decides to close down for good. In the best-case scenario he would simply sell the fixtures and miscellaneous assets, return the equipment to the leasing company by agreement, pay the taxes, hand the keys to the landlord by agreement, then legally dissolve the company and then walk away. But, Fred can’t do this, because the landlord won’t let him out of the contract, and the lease specifies that Fred is personally liable for the lease. The lease is just one example. There are other kinds of debts and contracts that can be enforced against a business owner when the business defaults. So, bankrupting only the business will not accomplish Fred’s goal of getting out of the lease. Fred will need to file a personal Chapter 7, as well. The company shares (if an LLC) or business assets (if a sole proprietorship) will be given to the trustee to sell and settle the debts of all of his creditors. Once the discharge happens, Fred is free of all the personal and business debts and contracts, including the lease.

Contact us for help

Business Bankruptcy Solutions helps Coloradoans lower their debts, renegotiate contracts and save their businesses. Call (720) 674-7311 or email now to schedule a free consultation. We will discuss the problems facing both your business and personal finances and the tools we can use to achieve your goals. We draw upon decades of legal and business experience to provide you with actionable solutions. With BBS on board, we’ll help you weather this storm.