What Is Liquidating Debt?

by Chris Blank Google
Chapter 7 bankruptcy allows you to eliminate many of your debts.

Chapter 7 bankruptcy allows you to eliminate many of your debts.

David Sacks/Lifesize/Getty Images

For individuals or companies that find themselves completely unable to meet their financial obligations, bankruptcy provides a way to obtain a fresh start. However, obtaining legal relief from debt often results in serious financial consequences. One of the most serious consequences of many Chapter 7 bankruptcy petitions is the process of liquidating your debt.

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Liquidation of Debt

As a condition of obtaining a discharge of eligible debts in a Chapter 7 bankruptcy petition, you must agree to the "liquidation," or sale, of nonexempt assets to generate cash. The cash generated from the sale of nonexempt assets is distributed among your eligible creditors. After your assets are sold and distributed to creditors, you have no legal further obligation to pay these discharged debts, even if the sale of nonexempt assets did not produce enough cash to fully repay the full amount you owed.

Exempt Versus Nonexempt Assets

During the Chapter 7 bankruptcy process, the courts appoint a trustee, often an attorney, to oversee the liquidation of your assets. The trustee distributes proceeds from your liquidated debts to your creditors to satisfy as much debt as possible. The trustee also schedules a meeting with you and your creditors, during which he questions you under oath about your assets, income and debts. However, the federal government has established a set of assets that are exempt from liquidation. Many states have established their own exemptions, which may differ from those allowed by the federal government. Common exemptions include tools used to make a living, a personal vehicle, clothing and personal effects. By contrast, valuable collections and second homes are often considered nonexempt. You may opt to use either state or federal exemptions, but you must adhere to one list or the other. The courts do not allow petitioners to pick and choose some items from the federal exemption list and some items from a state exemption list.

Chapter 7 Bankruptcy for Individuals

Many individuals who file Chapter 7 bankruptcy petitions have very limited amounts of assets. This is because the means tests applied to establish eligibility to file Chapter 7 bankruptcy eliminate many upper-income individuals and households. As a result, many individuals may have no non-exempt assets to liquidate. Although the obligation to pay for secured assets is eliminated with Chapter 7 bankruptcy, any liens against the property remain. However, Chapter 7 petitioners with houses or other secured property they wish to keep may be able to do so by maintaining current payments until the debt is paid off. On the other hand, if they fall behind in their payments, the creditor may seize the secured property.

Chapter 7 Bankruptcy for Businesses

Businesses that file for Chapter 7 bankruptcy protection must cease all operations upon filing the petition, which means going out of business. Just as with a personal Chapter 7 petition, a trustee is assigned to liquidate the assets of the business to pay the company's debts. Owners of corporations and limited liability companies would likely be exempt from losing personal property. However, business owners who have used personal property as collateral to obtain business credit may lose their personal property along with their business assets.