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By Michael S. Anderson of Anderson Tax Law logo for Arizona tax attorney Michael S. Anderson P.C.
  • Chapter 7 Bankruptcy – An Overview

    Chapter 7 bankruptcy is often called a “straight bankruptcy” or possibly just as often, a “liquidation bankruptcy.” More than 2 of 3 bankruptcy cases filed in Arizona Bankruptcy Court recently are chapter 7 cases. In an Arizona Chapter 7 bankruptcy case, the debtor is essentially seeking the “bankruptcy discharge”. This is a court order mailed to the debtor by the Arizona Bankruptcy Judge that essentially states that the debtor isn’t obligated to pay certain creditors.In exchange for this bankruptcy discharge, the debtor or person filing the case has to make some “trade-offs”. It is easiest to understand these “trade-offs” when they are spoken of in the context of the three primary parts of the Chapter 7 Bankruptcy. The first part or component of the case is the Income and Budget.The second is the “Assets” and the third “Liabilities”.

    1. Income and Budget

    In order to file a chapter 7 bankruptcy one must “qualify” to do so. The primary way that a person qualifies to file a chapter 7 case is to pass a Bankruptcy “Means Test”. This test was enacted by Congress in the “Bankruptcy Abuse Prevention and Consumer Protection Act of 2005” The test requires that the debtor disclose most income over a six month period prior to the filing date to the court. This income is averaged and from that average the Court subtracts various household expenses, some of which are based on IRS objective standards, some of which are based on actual average budget/household expenses. If the amount of money left over after the subtraction is complete, leaves an excess, a presumption may exist that the debtor isn’t eligible for a chapter 7 bankruptcy. If below the debtor should qualify to file.Also, if the excess is below the state of Arizona’s median level of income for a family of the debtor’s size, this means at least in most instances, that the debtor qualifies to file the chapter 7 bankruptcy without making the “subtraction”. Unless…there is still enough income to repay a good portion of the debt through a chapter 13 bankruptcy. In that case, even though the debtor’s average income may be below median, a chapter 7 bankruptcy may not work as well.

    2. The Assets

    Assuming that the filer has qualified to be in an Arizona Chapter 7 bankruptcy proceeding, a Judge will be assigned and a Chapter 7 bankruptcy trustee will be assigned. The Judge never meets the debtor in most cases but the Trustee does in almost every case. The Arizona Bankruptcy Trustee works for the federal government as an independent contractor. He or she has the primary responsibility to look closely at the filed bankruptcy documents, ask questions of the debtor and to find/review any assets.

    Once those assets are found, the Chapter 7 bankruptcy trustee will determine whether any of those assets should be sold and used to pay creditors even if only a partial payment. The trustee takes this asset liquidation process seriously i.e. he or she will really take certain assets and sell them.

    This is sometimes the largest “trade off” the debtor makes in exchange for the bankruptcy discharge. In most cases there are not any assets worth selling or that the Trustee can reach. This is because most assets fall under one of the four following types:

    Assets that are “liened”

    If a car is worth $20,000.00 and it is acting as security for a loan that is $25,000.00, the car has no equity. If there is no equity, the trustee isn’t interested.

    Assets that are leased

    Leased assets have no equity

    Assets that are exempt

    Arizona law protects certain assets from creditors. These laws are often called “exemption” laws in the context of an Arizona bankruptcy proceeding. Most Arizona bankruptcy filers are able to use these laws to protect from creditors and the bankruptcy trustee most assets. If the exemption applies, the bankruptcy trustee is out of luck. Many Arizona Bankruptcy filers are able to protect most of their assets using these laws or turn the non exempt assets into exempt assets prior to filing.

    Assets that are not worth much money

    Some assets are just “naked”. They aren’t exempt, they aren’t subject to a lien or lease. These assets aren’t protected from creditors and are up for grabs by the Arizona chapter 7 bankruptcy trustee. The trustee however is not always interested because they just aren’t worth very much.

    If all of the bankruptcy filer’s assets fall under one of these categories, than he or she will usually file a document with the court called a “report of no assets”. This lets everyone know that there is not anything available in the Trustee’s eyes worth liquidating.

    As stated, most bankruptcy cases are “no asset” cases. Often though, the trustee will expend a great amount of effort to uncover whether an asset doesn’t meet one of the categories above. If an assets is available and worth taking, the trustee will take possession, market the asset, and get the Arizona Bankruptcy Court’s approval to sell it. An Arizona Bankruptcy filer must be very aware of what assets they may lose if they choose to use bankruptcy to help deal with debt.

    3. The Liabilities

    Debtors who file chapter 7 bankruptcy petitions will as a general rule be “discharged” of his or her obligations. This is the goal of the case. What many don’t realize is that there are exceptions to the discharge. I.E. certain obligations survive the bankruptcy filing and the issuance of a “discharge notice” by the Arizona Bankruptcy Court. These exceptions can be divided in most cases into two separate types.

    Non Dischargeable Obligations as defined by the Bankruptcy Code

    Congress has decided ahead of time which obligations are not dischargeable. Things like recent income taxes, payroll taxes, trust fund tax, student loans(with some exceptions), child support and spousal maintenance, DUI related debt, criminal restitution and divorce related marital obligations are the most common types of debts that Congress thinks are too important to be subject to a bankruptcy discharge. There are others.

    Obligations that are Potentially Non Dischargeable

    There are debts that will be “discharged” UNLESS the creditor files a timely complaint with the Bankruptcy Court that challenges the discharge and than wins. Most of these types of actions are the result of some “bad conduct” by the debtor. The debtor may have “abused” a credit card prior to filing the bankruptcy i.e. used it alot with knowledge that a bankruptcy was going to be filed or that there was no way to pay it back. The debtor may have lied on an application for a loan, or defrauded someone, embezzled funds, breached a fiduciary obligation or inflicted a “willfull and malicious” injury on a person or property. Creditors in these types of cases are given a specific period of time to make the challenge.