The United States bankruptcy code is part of the federal legal code (meaning that it is very much the same in all fifty states, though there are some differences) and is divided into a series of chapters. Each chapter represents a different type of bankruptcy ranging from Chapter 7 for individuals and small businesses to Chapter 15 (for foreign entities operating in the United States). Chapter 7 bankruptcy, or straight bankruptcy, is the most common type of bankruptcy used by individuals in the United States and as such is generally what most people think of when they think about personal bankruptcy.
The basic idea is that the debtor lists all of his or her property, assets, and income and then lists all of their debts and liabilities. The court exempts the basic possessions needed for life and making a living and the remainder of the debtor’s property is liquidated through an auction. The funds received from the liquidation are used to pay off the creditors (at least in part and in a prioritized sequence) and the remainder of the debt is discharged, or essentially written off by the court. Although this very simple description covers the basics, in reality it is all vastly more complicated which is why bankruptcy law is a legitimate specialization within the legal profession.
The property that is deemed exempt from liquidation under Chapter 7 bankruptcy includes ones home, basic furniture and appliances, clothes, and other necessities for day-to-day life. Similarly, basic items needed by the individual to make a living – like tools or a vehicle – may also be exempt. What can be exempted differs by state and is one of those areas where having an attorney is extremely helpful. Needless to say, exempted items that secure debts – like a house with a mortgage or car still being paid on – may be exempt from liquidation but is not exempt from creditors and Chapter 7 bankruptcy cannot discharge the amounts owed on secured debts like this.
It is also important to note that Chapter 7 bankruptcy cannot discharge many other kinds of debts beyond secured loans (like a house mortgage or car payments). Section 523(a) of the bankruptcy code spells out a broad list of kinds of debts that cannot be discharged, and this should be reviewed before filing for bankruptcy in the first place. After all, if the debts in question cannot be discharged through Chapter 7 bankruptcy, it is pointless to file for it. These kinds of debt include, but are not limited to: (a) any sort of tax liability (federal, state or local); (b) any debt that is not specifically listed in the relevant schedule of the bankruptcy filing; (c) child support or alimony; (d) any sort of fees or fines or compensation ordered b y a court for criminal conduct; (e) any sort of debt owed to the government or any government agency or service (like student loans); (f) debts owed to certain tax-advantaged retirement arrangements (401(k)s or pension plans); and others.
Since 2005, a number of more stringent policies and practices have been mandated in Chapter 7 proceedings as well, making it more difficult to file and more difficult to have debt fully discharged. Chapter 7 bankruptcy can be a very good option in some circumstances, but may not be in others. It all comes down to the debtor’s individual circumstances and situation.
