Legal Definitions - Chapter 7 bankruptcy

Chapter 7 bankruptcy is a legal process under the U.S. Bankruptcy Code designed to help individuals and businesses resolve overwhelming debt by selling off assets to pay creditors.

Often referred to as "liquidation bankruptcy," Chapter 7 involves a court-appointed trustee who takes control of the debtor's non-exempt assets, sells them, and distributes the proceeds to creditors according to a specific legal hierarchy. For individuals, the primary goal is to obtain a "fresh start" by discharging most debts. For businesses, Chapter 7 typically means the permanent cessation of operations.

• For Individuals: An individual filing for Chapter 7 bankruptcy seeks to eliminate most of their unsecured debts, such as credit card balances, medical bills, and personal loans. To qualify, individuals must pass a "means test," which assesses their income and expenses to ensure they genuinely cannot afford to repay their debts through a Chapter 13 repayment plan. In exchange for this debt discharge, the individual must surrender any non-exempt assets (assets not protected by law, like certain equity in a home or car) to the bankruptcy trustee for sale.

• For Businesses: When a business files for Chapter 7, it signals the end of its operations. The business's assets are sold by a trustee, and the proceeds are distributed to creditors. Unlike individuals, businesses do not receive a "discharge" of their debts in Chapter 7. If the business entity were to somehow resume operations later, its debts would still exist, though this is rare as Chapter 7 typically dissolves the company.

The distribution of funds to creditors follows a strict order: secured creditors (those with collateral, like a mortgage lender) are typically paid first from the sale of their collateral, followed by unsecured creditors (like credit card companies), and finally, any remaining funds might go to equity holders (like stockholders).

Examples of Chapter 7 Bankruptcy:

• Example 1: An Individual's Fresh Start

  Maria, a single mother, lost her job unexpectedly and accumulated significant credit card debt and unpaid medical bills while searching for new employment. Despite finding a new job, her income is barely enough to cover her living expenses, making it impossible to pay down her substantial debt. After consulting with a bankruptcy attorney, she files for Chapter 7. A trustee is appointed to review her assets. Since her car is essential for work and has limited equity, and her household goods are modest, they are considered exempt. Her credit card and medical debts are discharged, allowing her to start fresh without the burden of overwhelming debt.

  How this illustrates Chapter 7: This example shows an individual using Chapter 7 to obtain a "fresh start" by discharging most of her unsecured debts. It highlights the role of the trustee in assessing assets and the concept of exempt property, which Maria gets to keep while her other debts are eliminated.

• Example 2: A Business Liquidation

  "The Daily Grind," a small independent coffee shop, has been struggling for years due to increased competition from larger chains and rising rent costs. Despite efforts to innovate and cut expenses, the owner, David, realizes the business is no longer viable and has no prospect of becoming profitable. He decides to close the shop and files for Chapter 7 bankruptcy for his business. A trustee is appointed to sell off the coffee shop's assets, including espresso machines, furniture, and inventory. The proceeds from these sales are then distributed to creditors, such as the equipment leasing company, suppliers, and the landlord, according to their legal priority. The business entity, "The Daily Grind LLC," ceases to exist after the liquidation.

  How this illustrates Chapter 7: This scenario demonstrates a business utilizing Chapter 7 to formally cease operations and liquidate its assets. It shows the trustee's role in selling business property and distributing funds to various business creditors, leading to the permanent closure of the company.