Chapter 7 Bankruptcy – Essential Chapter 7 Guide (2021 Update)
Chapter 7 bankruptcy changed for California in 2021. A lot of this is due to the new California homestead exemption. This is key because this is the type of bankruptcy where they can take your things. Read on in this ultimate guide on Chapter 7 bankruptcy.
Chapter 7 Bankruptcy Definition
For those seeking a Chapter 7 bankruptcy definition, it’s this: a debt solution for those honest but unfortunate people who can’t afford to repay any debt, where unprotected assets can be taken from you and sold to pay your debts.
First, Chapter 7 bankruptcy is the most common type of bankruptcy. It doesn’t mean it’s the “better” type of bankruptcy, or even the right one for you. Next, in Santa Clarita and Los Angeles County, we’ve successfully helped thousands of people file Chapter 7 cases over the past two decades.
In short, if you qualify, then you don’t have to pay debt back, and the process is relatively quick. This is part of the allure of Chapter 7 bankruptcy. But it has dangers that often outweigh the benefits.
The Pros of Chapter 7 Bankruptcy
First, let’s look at the good parts about Chapter 7 bankruptcy. There are a couple
You Don’t Repay Debt
In Chapter 7 bankruptcy, no one gets repaid. You don’t pay a single cent to any of your debts. Doesn’t that sound great? Before, you were making minimum payments forever. Now, you’re done, no more payments, finished, done, finis.
Chapter 7 bankruptcy is over in a few months
That’s right. In Chapter 7, it’s over in a few months. File some papers, and magically the whole thing is over in less than half a year, typically. No long open case dragging on for years. Doesn’t this sound wonderful?
Cost of a bankruptcy is cheap, given your debts
The bankruptcy cost, while it varies from case to case, is probably way less than you owe on all your debts. And, how much debt do you owe? Five thousand? Ten? $25,000 in credit card and medical bills? $40,000? The bankruptcy cost will be way, way less than all that. When you figure bang for the buck, the bankruptcy cost is, frankly, a deal.
Sound too good to be true? But there are, as you may have guessed, problems and downsides to Chapter 7 bankruptcy.
The Cons of Chapter 7 bankruptcy
Liquidation: People really lose things in bankruptcy
First, it’s liquidation. It’s right there in every brochure about Chapter 7 bankruptcy: “liquidation.” It means they liquidate your assets to pay your debts. On the left hand, you have stuff. On the right hand you have debt. Stuff on the left hand is used to pay the right. You can lose things in Chapter 7 bankruptcy.
People really lose things in Chapter 7 bankruptcy.
This may seem completely unfair. Why should they take things you need. But it’s the law, and it has all the swiftness and precision of a guillotine.
Now, let’s consider some very reasonable responses to this:
- Necessity: “But I need my car to get to work.” – not a legal argument, you can lose it.
- Shelter: “But I live in my house” – not a legal argument, they can sell it and evict you.
- Livelihood: “But I need my small business to survive.” – not a legal argument, they can sell your small business.
- Possession: “But I don’t have my tax refund (or other account receivable) yet.” – not a legal argument, they can take it
Summing up, then, what you’d consider very reasonable reactions to them taking your things don’t hold water, legally. This is often when people who filed bankruptcy without a bankruptcy attorney will call our office and ask to be rescued. Oftentimes, there’s not a lot we can do at this point. It’s too late.
People really lose things in Chapter 7 bankruptcy. It’s called “liquidation” for a reason.
You may figure that if they’ll take something from me, I’ll just give it or “sell” it to Uncle Charlie. Which gets us to another downside.
A Gift Horse
Second, a bankruptcy trustee can track down and go after things you did have but no longer do. If you had a 1955 Thunderbird that you sold to a friend for a dollar last year, you didn’t solve anything. The problems are just beginning. For the same reason you would want to to do this, you are not allowed to do it.
The Chapter 7 trustee has a duty to pursue assets that have been transferred away recently — or even not recently. You thought you were outsmarting the trustee by ditching it. Wrong. It’s a problem for the very reason you did it.
The Chapter 7 trustee can now go after Uncle Charlie for the asset you gave/sold to him. And if it’s gone, yes, they can even sue the recipient for the value of the asset. And use that to pay your debt. And you may risk having your bankruptcy go through completely.
Welcome to the world of fraudulent transfer.
READ MORE: See my deep dive on fraudulent transfers in California.
No fraudulent intent required
But, you may say, you didn’t intend to trick anyone. You just gave your daughter half your house because you didn’t want to write a will and she’ll inherit it anyway.
It doesn’t matter.
There doesn’t need to be intent to have fraudulent transfer kick in. Your daughter is now a possible target of a lawsuit for her half of the house. The ironic part of this is they can even go after the half of the house that was transferred even if the entire house equity was protected had you kept the whole thing.
What you want in a bankruptcy case is a bankruptcy discharge. That’s the golden ticket. Now you don’t owe that debt.
Problem is, a lot of debts don’t go away in a Chapter 7.
For example, tax debts are typically not discharged. Same with student loans.
Fraud and False Pretenses
Also, fraudulent debts don’t go away. You may think you’re safe here, since you’re likely a good person. But it’s possible that exaggeration on your credit card application may be fraud.
Or that credit card spending you did in the past year. Maybe you intended to repay it, then something suddenly came up. Credit cards can challenge recent — even innocently borrowed — debt as fraud.
This is almost always a surprise to the debtor who didn’t even realize they did anything wrong. This is also a good reason to meet with a bankruptcy attorney and be completely honest with him or her. You don’t know what you don’t know.
Which gets us to…
“It’s all gone”
Yet another downside of Chapter 7 bankruptcy, as they put your past under the microscope, is that money you had but can’t account for. This can come up when someone cashed out a 401k or other retirement account a year ago. The Chapter 7 bankruptcy attorney (and then the trustee) asks, “where did all this money go?”
And the answer? 99 times out of 100:
“It’s all gone.”
Fraudulent Transfer or Bad Faith?
This is not the end of the story, but just the beginning. Because now the Chapter 7 bankruptcy trustee will demand a full accounting of where every penny went, and question the reasonableness of the spending.
And again, the tragic irony is that had the retirement money stayed in the IRA, it may have been safe and protected. (More on that below)
This is not intended to be a complete list of the hall of horrors that await in a Chapter 7 bankruptcy. People who calls us (or we read about) are always surprised when a case goes sideways.
It cannot be stressed enough: Chapter 7 bankruptcy is not “just forms” and you can lose things, have your friends and relatives get sued, be denied a discharge, or even end up in jail. At the very least, meet with a Chapter 7 bankruptcy attorney before you do anything. I don’t pressure. As you can tell from this guide, I go out of my way to inform, to help, to protect. Let’s meet.
And there lurk other pitfalls of possible disaster. Not knowing all the dangers and monsters in this complex area of law has burned more than a few people, even innocent and well-intentioned ones. If you contact a Chapter 7 bankruptcy attorney after things are blowing up, it may be too late to undo what is already done.
Bankruptcy Exemptions: The Art of Keeping Things
So there are pros and cons to Chapter 7 bankruptcy, and the cons can be major and huge. But there is one tool a skilled bankruptcy lawyer has: exemptions.
Exemptions are what you use in Chapter 7 bankruptcy to try to protect and save your things. Each type of property or asset you have has a limit or dollar amount of what can be saved. Some are unlimited.
These are different in every state, and there are rules to prevent you from moving from one state to the other and using the exemptions of the new state. This happens even if you didn’t intend to use the new state’s exemptions. (sensing a theme here?)
California Bankruptcy Exemptions
California Exemptions, Generally
In California, some types of things are protected in one type of exemption, and completely unprotected in the another type of exemption. So choosing the right bankruptcy exemption can make all the difference between, say, keeping your house or losing it, or the tax refund, car, etc.
A lot of times, it comes down to making a choice of what you want to keep, and what you want to risk losing.
Sometimes You Can’t Keep it All
But the good news is, they don’t take the shirt off your back. Unless you have a lavish wardrobe of someone on MTV: then they can sell a lot of your shirts. But you get to keep a few.
The point is, there’s a standard list of things you can keep, and your stuff may or may not fit the list. And remember, there are things you don’t even think of as “assets” that are. This is always another surprise.
I can’t cover the broad definition of property law here, but again, you want to meet with a bankruptcy lawyer before filing a Chapter 7 bankruptcy. So, in California exemptions, there are two tracks.
This is a way to protect some cash money, savings or checking accounts, tax refunds, and gets you a “wild card” to use for whatever. There’s very little available to protect a house though.
This is a way to use a homestead exemption to protect a house, but is very limited in what else it can do and has major drawbacks when it comes to cash and cars and tax refunds.
Keep My Car / House
You might ask, what about my car… can I keep my car or do I have to include it in the Chapter 7 bankruptcy? And the answer is yes. You have list all your assets in a bankruptcy, and a car or house is an asset, even if you’re financing it.
The next issue is, if I list it, can my keep my car or home in a Chapter 7 bankruptcy, and answer is that it really depends. Often, people can keep the home or car, but there a few variables now.
Pay It If You Want to Keep It
First, you have to, of course, stay current on the car or house payments, because you don’t a free car or house in Chapter 7 bankruptcy.
You don’t get a free car or house in Chapter 7 bankruptcy
Now, that may sound extremely obvious, even comical. “Of course you don’t get a free car,” you laugh. But there’s a reason I wrote this twice, and even highlighted it as a big blockquote. Your lender may stop sending you statements. But you cannot stop sending them money.
Second, your car lender can send you reaffirmation agreements in bankruptcy. If you want to keep the vehicle, you have to complete the agreement and return it to them. This means you’ll owe the debt after bankruptcy if you stop paying for the car.
Finally, does your car or house have too much equity? Because even if the lender won’t take it from you, the bankruptcy trustee sometimes can.
2021 update: There are changes in the California homestead exemption which may be able to help you protect more home equity.
What Can I Keep in Chapter 7
But beware. Remember (and I’ll keep repeating it), we talked about Chapter 7 bankruptcy is what they call liquidation bankruptcy. That is, you can lose stuff.
You say, “I don’t have anything for Chapter 7 bankruptcy to take… my case is the easiest one ever!” But aside from home equity, cars, and money in the bank, there are other assets you may have that aren’t so obvious. What about that claim someone owes you that you may or may not be suing them for?
Or maybe that tax refund that you may get this year? Do we consider that thing you gave to your ex or brother or cousin, or that family debt you paid back 3 months ago? Or that money your daughter owes you? And where ever did all that money go you got from that big settlement you got 2 years ago?
Chapter 7 Bankruptcy Eligibility
Qualifying for Chapter 7 Generally
So, maybe you’ve read this far, and Chapter 7 bankruptcy sounds great to you. The pros outweigh the cons. You think you can keep your stuff, or at least the stuff that matters. The debt that doesn’t go away you’re ok with.
After all that, not everyone qualifies for Chapter 7 bankruptcy. There is a means test and government chart put out that determines who can more easily qualify for Chapter 7. It’s based upon current income.
The theory is that the more income you earn, the greater the chance you can afford to pay some debt. If you can afford debt repayment, then you’re not eligible for Chapter 7 bankruptcy.
People who earn too much income for a Chapter 7 can still do a Chapter 13 bankruptcy. The more money you earn, the harder it is to be eligible for Chapter 7 bankruptcy. Congress decided that a couple earning, say, over $100,000 a year probably has money to repay some debt.
READ MORE: Chapter 13 Bankruptcy – A Better Solution
Summing up, Chapter 7 bankruptcy looks at really two things: whether you qualify in theory with the means test, and whether you are eligible for Chapter 7 bankruptcy by looking at your actual budget.
Chapter 7 Means Test
You may earn a lot of money, but maybe it all goes to taxes, or a mortgage. To try to be fair, Congress made a formula to filter out high-earning people with debt so Chapter 7 bankruptcy is only for those who truly need it. The means test looks at:
- Earned income you’ve (and the household) earned the past six months.
- Your car payments or mortgage payments.
- How much priority tax debt is involved.
- And a bunch of other factors.
The bankruptcy means test really is in two phases. First, do you make above or below a given number for your household size in your state.
Second, assuming you make more, do you have enough allowable deductions to help you get back under the line. It’s as easy as that, and as hard as that.
The Chapter 7 means test is a very long form, and it factors in IRS averages regardless of your spending, along with some actual numbers from your budget. It’s a skill to complete it (and can take a lot of time to input every pay stub), but a good bankruptcy attorney can maximize your chances of Chapter 7 bankruptcy eligibility.
Finally, after everything is calculated, either the person/couple qualifies for Chapter 7 or doesn’t. If their income is too high, there are still options. Maybe earnings can go lower in the months ahead, so it could be prudent to wait.
With the coronavirus economy, house prices have gone up in Santa Clarita and Los Angeles County. This, along with the increased California homestead exemption, makes losing your home to liquidation in Chapter 7 bankruptcy more of an unknown risk. If the house can be protected, cash and cars can’t (as much).
Maybe the better option is to just file Chapter 13 bankruptcy and pay back whatever you can afford.
Either way, there’s usually a solution.
Chapter 7 Bankruptcy: Summing Up
This is a way to maybe eliminate debt without repayment, but you have to qualify. Even if you are eligible for Chapter 7 bankruptcy, be careful what you wish for. You can lose things.
Whatever you do, see a bankruptcy attorney or you risk losing your stuff. A friend, uncle or bankruptcy paralegal telling you what exemptions to take is practicing law without a license, and cause you harm.
Meet with a bankruptcy lawyer. People really do lose things in a Chapter 7 bankruptcy. The good news is, with proper planning, there is a way to avoid disaster and find a path to being debt-free that is safe and without risk.
To find out if you qualify for Chapter 7 bankruptcy, give us a call. Maybe we’ll run the means test for you, or go over other options for you. Contact us now.
Author: Hale Andrew Antico
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