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How Chapter 7 Bankruptcy Works

Chapter 7 Bankruptcy is also known as the “liquidation” chapter of the Bankruptcy Code. Liquidation means that a debtor’s nonexempt property may be sold by a bankruptcy trustee and the proceeds distributed to the debtor’s creditors. However, there are many property exemptions available to debtors filing for bankruptcy in New York. Consequently, in the majority of Chapter 7 bankruptcy filings in New York, debtors keep all of their property. It is important to keep in mind that each state has different laws regarding property exemptions.

After a debtor has filed for Chapter 7 bankruptcy, a bankruptcy trustee is appointed by the court. If the debtor owns any nonexempt assets, the trustee may sell those assets and distribute the proceeds to the debtor’s creditors. However, people filing for Chapter 7 bankruptcy in New York are afforded generous property exemptions. Property that is exempt is retained by the debtor in a Chapter 7 bankruptcy. Debtors in New York can choose between the exemptions provided by either New York law or the federal Bankruptcy Code.

The Chapter 7 Means Test

A person’s eligibility to file for Chapter 7 bankruptcy is determined by the “means test”. The means test requires a two-step analysis. First, the debtor’s “current monthly income” must be calculated. Current monthly income is based on the debtor’s average monthly gross income from all sources (except social security), received over the six-month period preceding the bankruptcy filing. Income includes a spouse’s income, whether or not the spouse is also filing for bankruptcy (unless the debtor and spouse are living in separate households). In addition, any contributions to household expenses made by other persons (usually other adult family members) are included in calculating the debtor’s current monthly income. If the debtor’s annualized current monthly income is less than the median income for New York State, then the debtor is eligible to file for Chapter 7 bankruptcy.

The following is the median income in New York State, based on family size, according to the U.S. Census Bureau, as of May 15, 2024:

  • One Person in Household      $69,135

  • Two People in Household       $87,550

  • Three People in Household    $105,435

  • Four People in Household      $131,389

  • For households exceeding four people, add $9,900 for each individual in excess of four

If the debtor’s current monthly income is over the median income for New York state, then the second step of the analysis must be performed. In this second step, various deductions are taken off the current monthly income to arrive at the debtor’s “monthly disposable income”. Some of the deductions are based on Internal Revenue standards. Other deductions are specific to the debtor’s actual expenses. If the debtor’s monthly disposable income is less than the limits set by the bankruptcy code, then the debtor qualifies for Chapter 7. If the debtor’s monthly disposable income exceeds the limits set by the bankruptcy code, then a “presumption of abuse” applies. In that event, the Chapter 7 case would be subject to dismissal, and the only alternative would most likely be for the debtor to file a Chapter 13 bankruptcy. Read more about the Chapter 7 means test.

The means test does not apply if:

  • The debts incurred by the debtor are not primarily consumer debts (i.e. over 50% of the debts are business-related debts).

  • The debtor is a disabled veteran whose indebtedness occurred primarily during a period in which the debtor was on active duty or while performing a homeland defense activity.

  • The debtor was a member of the Armed Forces Reserves or National Guard who was on active duty or homeland defense for at least 90 days during the 540 days preceding the bankruptcy filing.

Secured Debts vs. Unsecured Debts in Chapter 7

In a Chapter 7 bankruptcy, the distinction between secured and unsecured debts is very important. A secured creditor retains an interest (called a “lien” or “security interest”) in certain property, known as “collateral”. Usually, the creditor has extended credit to the debtor specifically for the purchase of the particular property. The most common example is a loan for the purchase of a motor vehicle. Another example is a mortgage in real property, whether for a purchase, refinancing or home equity loan. If the borrower fails to make the required payments, the collateral can be repossessed (as with a motor vehicle) or foreclosed on (as with real property).

Unsecured debts, on the other hand, do not have any collateral attached to the debt. The most common types of unsecured debts are credit cards, personal loans, and debts for services performed (e.g. medical debts). Generally, these types of debts are discharged in a Chapter 7 bankruptcy.

In a Chapter 7 bankruptcy, secured creditors generally retain their liens in the debtor’s property, and the debtor will continue to make regular payments to the secured creditor. It is important to note that the debtor’s personal obligation to pay the debt is discharged in the bankruptcy proceeding unless a reaffirmation agreement is filed with the court. If a reaffirmation agreement is not filed with the court, and the debtor then fails to make the payments, the creditor’s only recourse is to repossess or foreclose on the property. That is, the creditor cannot sue the debtor for failure to pay the debt.

Right of Redemption in Chapter 7

Section 722 of the Bankruptcy Code allows a Chapter 7 debtor to remove a lien on personal property by paying the secured creditor the market value of the property. For instance, if the debtor owes $10,000 on a car worth $5,000, the debtor can pay the creditor $5,000, thereby eliminating the creditor’s security interest. This may be a viable option for debtors who have sufficient cash (that the debtor has exempted). Also, debtors may be able to obtain financing that is specifically offered for redemption purposes. While the interest rate for these loans is high, the lower principal amount can result in substantial savings for the debtor.

What is a Reaffirmation Agreement?

When a debtor signs a reaffirmation agreement for a secured debt, the debtor remains liable for the debt and must continue to pay the balance due to the creditor. If the debtor fails to do so, then the collateral can be repossessed, and the debtor will be liable for any deficiency owed. A deficiency is a difference between the balance due on the loan and what the secured creditor receives for the collateral at auction. Certain creditors have been known to repossess vehicles if the debtor does not sign a reaffirmation agreement, even if the debtor remains current on the loan (the bankruptcy code permits creditors to do so).

Whether or not a debtor should sign a reaffirmation agreement is an important decision and will depend on many factors, most importantly the debtor’s ability to repay the loan. Every Chapter 7 client of Andrew M. Doktofsky is provided with a thorough explanation of the pros and cons of signing a reaffirmation agreement.

The reaffirmation agreement must be in writing and must be filed with the court before the discharge is entered.

Read more about reaffirmation agreements in Chapter 7

What Happens After the Chapter 7 Discharge?

After the court grants the debtor a discharge under Chapter 7, the debtor is no longer liable for most debts that were incurred prior to the filing of the bankruptcy proceeding. This means that a debtor’s creditors cannot pursue any new or continued legal action against the debtor to collect these debts. However, there are certain debts that are not discharged in a Chapter 7 bankruptcy.

Read more about nondischargeable debts in Chapter 7.

A debtor’s discharge may be denied by the court for a number of reasons, including:

  • The debtor failed to keep or produce sufficient financial records

  • The debtor failed to adequately explain any loss of assets

  • The debtor committed a crime associated with bankruptcy, i.e. perjury

  • The debtor failed to follow an order of the bankruptcy court

  • The debtor fraudulently transferred, concealed or destroyed property that would have been the property of the debtor’s estate

  • The debtor failed to complete an approved post-filing financial management course

The bankruptcy court may revoke a Chapter 7 discharge upon the request of a trustee or creditor if the discharge was obtained fraudulently; the debtor acquired property and failed to report the property or surrender the property to the trustee; the debtor made an important misstatement of fact, or the debtor failed to provide documents or other information related to the debtor’s financial situation.

Free Consultation for Chapter 7 Bankruptcy

Contact the Law Office of Andrew M. Doktofsky today for a free consultation about filing for Chapter 7 bankruptcy in Suffolk County, Nassau County, New York City, and surrounding areas. Andrew M. Doktofsky will determine if Chapter 7 bankruptcy is appropriate for you and will guide you through the bankruptcy process.

Andrew M. Doktofsky P.C.  is a debt relief agency. I help people file for bankruptcy relief under the Bankruptcy Code.

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