Chapter 7

From Academic Kids

Liquidation under Chapter 7 of the Bankruptcy Code is the most common form of bankruptcy in the United States.


Businesses filing Chapter 7

When a troubled business is badly in debt and unable to service that debt or pay its creditors, it may file (or be forced by its creditors to file) for bankruptcy in a federal court under Chapter 7 (liquidation) or Chapter 11 (reorganization). A Chapter 7 filing means that the business intends to sell all its assets, distribute the proceeds to its creditors, and then cease operations.

This may or may not mean that all employees will lose their jobs; when a very large company enters Chapter 7 bankruptcy, it may be that entire divisions of the company are sold intact to other companies during the liquidation.

Secured creditors, such as bondholders, have a higher-priority claim on the proceeds than unsecured creditors, such as vendors who have not yet been paid for products they previously delivered to the company.

A corporation or other legal entity that is a debtor under Chapter 7 is not entitled to a discharge of its debts: once all assets of the company have been fully administered, the case is closed and the debts of the entity, theoretically, continue to exist.

Individuals filing Chapter 7

Individuals can file for bankruptcy in a federal court under Chapter 7 ("straight bankruptcy", formally liquidation) or Chapter 13 (a "reorganization", formally debt adjustment case). In a Chapter 7 bankruptcy, the individual is allowed to keep certain exempt property, and most liens, such as real estate mortgages, survive. Other assets, if any, are sold (liquidated) by the interim trustee to repay creditors. Many types of unsecured debt are cancelled. There are 19 (as of 2005) general classes of debt not discharged in a Chapter 7. Common exceptions to discharge include child support, most taxes, most student loans (unless the debtor prevails in a difficult-to-win adversary proceeding brought to determinate the dischargeability of the student loan), and fines and restitution imposed by a court for any crimes committed by the debtor.

A disadvantage of filing for personal bankruptcy is that a record of it stays on the individual's credit report for 10 years. This may make credit less available and/or terms less favorable. That must be balanced against the removal of actual debt from the filer's record by the bankruptcy, which tends to improve creditworthiness. Consumer credit and creditworthiness is a complex subject, however. Future ability to obtain credit is dependent on multiple factors and difficult to predict.

Another aspect to consider is whether or not the debtor can avoid a challenge by the United States Trustee to his or her Chapter 7 filing as abusive. One aspect of whether the U.S. Trustee can prevail in a challenge to the debtor's Chapter 7 filing is whether or not he can otherwise afford to repay some or all of his debts out of disposable income in the three year time frame provided by Chapter 13. If so, then the U.S. Trustee may succeed in preventing the debtor from receiving a discharge under Chapter 7, effectively forcing the debtor into Chapter 13.

It's widely held amongst bankruptcy practioners that the U.S. Trustee has become much more aggressive in recent times in pursuing (what the U.S. Trustee believes to be) abusive Chapter 7 filings. Through these activities it is achieving what the Congress and most creditor-friendly commentors have consistently espoused, i.e., a formal means test for Chapter 7. The Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 has clarified this area of concern by proposing changes to the U.S. Code that include, along with many other reforms, language that acts as an explicit means test for Chapter 7.

Creditworthiness and the likelihood of receiving a Chapter 7 discharge are only a few many issues to be considered in determining whether to file bankruptcy. The importance of the effects of bankruptcy on creditworthiness is sometimes overemphasized because by the time most debtors are ready to file for bankruptcy their credit score is already ruined.

2003 Statistics

Bankruptcy filings by individuals:

  • Chapter 7 filings: 1,156,284
  • Chapter 11 filings: 959
  • Chapter 13 filings: 468,562

Bankruptcy filings by businesses:

  • Chapter 7 filings: 21,008
  • Chapter 11 filings: 9,185
  • Chapter 12 filings: 698
  • Chapter 13 filings: 5,201

The total number of bankruptcies rose 7.4 percent over the previous twelve months. These totals were for the 12-month period ending September 30, 2003.

Source: November 14 2003 News Release, Administrative Office of the U.S. Courts. (External link to PDF file: [1] (

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