Chapter 7 bankruptcy is one possible solution to the problems caused by harassing creditors and the pressure of dealing with overwhelming debt. It is designed to give debtors a fresh start financially by eliminating their debts. Not everyone is eligible for Chapter 7 bankruptcy, however. Only individuals, as opposed to partnerships and corporations, may file under Chapter 7, and they must meet a number of eligibility requirements.
Chapter 7 vs. Chapter 13 Bankruptcy
Chapter 7 bankruptcy, the most common type of consumer bankruptcy, is sometimes referred to as “liquidation bankruptcy” because it eliminates most debts and allows the court to seize and sell all available assets to repay creditors. Generally, a Chapter 7 bankruptcy case takes approximately 90 days to complete. Chapter 13 bankruptcy, another option, allows you to keep all property if you agree to a plan to make monthly payments for three to five years to satisfy your creditors. At the end of the Chapter 13 repayment period, most outstanding balances are discharged, and the debtor is no longer responsible for paying them.
The vast majority of debtors who want to file a Chapter 7 bankruptcy must first pass a means test, which determines whether the debtor has enough disposable income to fund a Chapter 13 repayment plan. If so, she may not use Chapter 7 bankruptcy. To make this determination, the means test first compares the debtor’s income with the median income of a family of the same size in that state. If the debtor’s income is lower than the median family income, she qualifies for Chapter 7. If the income is greater than the median family income, the debtor may deduct additional expenses as allowed under relevant state law. If the debtor's income less allowable expenses is still greater than the state's median family income, the debtor must use Chapter 13.
Computations for the Means Test
The median income for a family of the debtor’s size in the appropriate state is determined using the bankruptcy court's forms. Once, the median income level is determined, the debtor states her current income, the debtor’s average monthly income over the six-month period immediately prior to filing for bankruptcy. It consists of all income the debtor has received over that period divided by six to determine the monthly average. That figure might not actually reflect the debtor’s current income at the time of filing bankruptcy if the debtor lost her job in that period and had not received income for each of the six months.
When Chapter 7 is Not Available
A debtor may be barred from proceeding under Chapter 7 if she has too much disposable income and so fails to pass the means test. A debtor who filed for Chapter 7 within the last eight years, or who filed under Chapter 13 within the last six years of filing for bankruptcy, is also prohibited from filing under Chapter 7. The period runs from the date the prior bankruptcy paperwork was filed, not from the date it was finalized. Generally, a debtor is also barred from filing for six months from an earlier bankruptcy case that was dismissed.
Assuming that the debtor qualifies to file under Chapter 7, she must then receive a certificate of completion from a nonprofit credit counseling agency. Those who are on active military duty, incapacitated or have a disability that prevents participation in counseling are exempt from the requirement. The certificate is filed along with the initial bankruptcy petition. The purpose of the credit counseling requirement is to determine whether there is a feasible alternative to bankruptcy. If the counselor determines that an alternative exists, the debtor can still file for bankruptcy, but must inform the court of the counselor’s suggested alternative.
Alternatives to Chapter 7
Debtors should explore whether there are any reasonable alternatives to bankruptcy before filing. For example, they may be able to negotiate with creditors to extend repayment periods, reduce interest rates, or pay off existing balances with a reduced lump-sum payment. They may explore the possibility of obtaining a consolidated loan, whereby the consolidation company pays off the debtor’s debts in full and the debtor makes a single lower payment to the consolidation company. If the debtor has property that the court can seize, along with enough income to fund a repayment plan, she may want to explore the possibility of filing under Chapter 13 rather than under Chapter 7.