Bankruptcy Law

In this video, we will provide an overview of Chapter 7 Bankruptcy. It's crucial to note that bankruptcy is governed by federal procedures, taking precedence over any conflicting state laws. All relevant information regarding bankruptcy can be found in Title 11 of the United States Code, commonly referred to as the bankruptcy code.

Eligibility for Chapter 7 extends to single individuals, married couples, businesses, and legal partnerships. There is no specific minimum amount that a debtor must owe; however, debtors who exceed a certain level of income cannot file Chapter 7 and must file under Chapter 13 instead.

A Chapter 7 bankruptcy allows a debtor to eliminate their debt by liquidating the debtor's non-exempt assets and using those assets to pay their creditors with the proceeds. Any amount left owing to creditors after all assets have been liquidated and paid out is considered discharged, which means the debt is no longer collectible by the creditor.

Two types of debt are addressed in bankruptcy: unsecured and secured. Unsecured debts are amounts owed to creditors who do not insist on real or personal property to be pledged as security for the debt. Medical bills, credit card balances, and personal loans are common examples of unsecured debt. Car loans, furniture loans, and mortgages are examples of secured debt.

While both unsecured and secured debt can be completely eliminated in a Chapter 7 with certain exceptions, secured debt is treated differently depending on the debtor's intentions. A debtor can eliminate a secured debt by surrendering the property securing the debt, and if the debtor owes more than the property is worth, the unsecured portion of the debt is discharged. Alternatively, if the debtor is current on the secured loan payments at the time of filing bankruptcy, the debtor can reaffirm the debt in the bankruptcy, agree to continue payments, and keep the property securing the debt. Many debtors reaffirm their car loans in Chapter 7.

When an individual files bankruptcy, all of the assets they own become part of their bankruptcy "estate." However, certain assets are exempt from inclusion in the bankruptcy estate and therefore cannot be liquidated and used to pay creditors.

Examples of typical items that are considered exempt in Arizona as of January 1st, 2024:

• Homestead Protection: For a primary residence in Arizona, with equity coverage up to $414,700. To qualify for the full exemption, the debtor must have owned the property for 1215 days; otherwise, the exemption will be lower.
• Vehicles: For a single person, protection for up to one vehicle with equity not exceeding $15,600. If the individual is legally disabled, equity protection increases to $26,000. Married couples can retain up to two vehicles, each with equity protection up to $15,600. If one or both spouses are legally disabled, equity protection for each vehicle rises to $26,000.
• Retirement Accounts: 100% exempt
• Social Security Income: 100% exempt

Examples of typical items that are not considered exempt, meaning they are NOT protected:

• Additional nonexempt vehicles
• Personal homestead if it has more than $414,000 equity; other real estate that is not considered primary homestead
• High value jewelry
• Lawsuit claims that are pending at the time of filing bankruptcy, this will include personal injury proceeds

• Most Taxes
• Child Support
• Alimony
• Most Student Loans
• Court Fines and Criminal Restitution
• Any debt obtained by committing a crime, for example, a personal injury claim cost against the debtor caused by drunk driving or under the influence of drugs, or any debt obtained by means of fraud.

When a Chapter 7 bankruptcy is filed, the U.S. Trustee appoints an impartial case trustee to administer the case and start liquidating the debtor’s non-exempt assets. If all the debtor’s assets are exempt or subject to valid liens, the trustee will normally file a “no asset” report with the court, and there will be no distribution to unsecured creditors. Most Chapter 7 bankruptcies involving individual debtors are no asset cases.

The primary role of a Chapter 7 trustee in an asset case is to liquidate the debtor's nonexempt assets in a manner that maximizes the return to the debtor's unsecured creditors. The trustee accomplishes this by selling the debtor's property if it is free and clear of liens (if the property is not exempt) or if it is worth more than any security interest or lien attached to the property and any exemption that the debtor holds in the property. The trustee then distributes the proceeds proportionally to creditors who filed Proofs of Claim in the debtor's case.

The "means test" is a standardized tool used by the bankruptcy court in Chapter 7 cases to determine if a debtor's income is low enough to file Chapter 7. First, the debtor performs a calculation of their average monthly income over the past six months, including all sources. If the debtor's income is below the median for a household of its size in their state, the debtor typically qualifies. If it's above, the debtor can deduct certain allowed expenses to bring their income calculation below the minimum threshold, thereby qualifying the debtor to file. If, after subtracting all allowable expenses, the debtor's income is still over the threshold, they will likely be redirected to Chapter 13. Currently, the median income for a single person is $63,717; for a family of 2 is $80,352; for a family of 3 is $90,789; for a family of 4 is $103,676.

The following example does not imply any form of legal advice; however, it serves to enhance your understanding of how Chapter 7 bankruptcy operates:

A married couple with two children is considering filing for Chapter 7 bankruptcy. Their combined income is $95,000. They own a property that serves as their primary homestead, with an outstanding mortgage of $450,000 and a current market value of $600,000. Additionally, they carry approximately $58,000 in credit card debt. They own three vehicles, one of which is fully paid off and valued at about $13,000. The remaining two vehicles have outstanding debts of $10,000 and $3,000, with values of $10,000 and $20,000, respectively.

In terms of income, they are below the median income for a family of four. Assuming no fraud and a successful "means test," they can anticipate the following outcomes:

• The house would be exempt and protected.
• Two of their vehicles are protected. The paid-off vehicle is exempt as its value is less than $15,600. Regarding the other two vehicles, they must choose which one to surrender. If they surrender the $10,000 debt vehicle, it will be picked up, and the entire debt will be discharged. If they choose the $3,000 debt vehicle, it has $17,000 equity, with only $15,600 protected. In this case, they can propose to reaffirm the debt with the creditor and pay the difference of $2,000 to the trustee.
• Student loans are not dischargeable, and they must continue making payments.
• The unsecured debt of $63,000 would be completely discharged.

According to the Fair Credit Reporting Act, a Chapter 7 bankruptcy remains on the debtor's credit report for a duration of 10 years. Despite the extended timeframe, many lenders may be inclined to offer credit to individuals at significantly elevated interest rates. This is often exploited under the understanding that the individual is restricted from filing for bankruptcy under Chapter 7 for an additional 8 years.

It is essential to emphasize that if a debtor encounters a situation necessitating borrowing funds to cover the legal fees and court filing fees (which incidentally amount to $338), it is imperative to formally acknowledge the individual who provided the loan as a creditor in the bankruptcy filing. Conversely, if a family member or a loved one wishes to assist the debtor by offering the funds as a gift, such a contribution is considered permissible.

Furthermore, in the context of legal fees, the same principle applies. If the legal fees are structured on a payment plan, the debtor's attorney is regarded as a creditor, and must be included in the bankruptcy petition. However, it is noteworthy that no attorney exercising sound judgment would typically choose this route. It is crucial to bear in mind that if the debtor engages a bankruptcy attorney on a payment plan, the attorney will refrain from filing the case until their fees are paid. Otherwise, their fees become part of the overall bankruptcy debt.

Finally, there are 2 classes that need to be taken. The first one is a credit counseling class that must be taken before the filing of the Bankruptcy case, and the second one is a debtor education class that must be taken after the case is filed, but before a discharge is entered. From beginning to end, the typical Chapter 7 bankruptcy case spans four to six months.

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Credit for this script:
Author: Felix Martinez
Attorney that checked for correct information and to make sure there was no legal advice given: Jennifer Nichols-Moore
Other information obtained from:
https://www.justice.gov/ust
https://www.azb.uscourts.gov/
https://www.azleg.gov/viewdocument/?docName=https://www.azleg.gov/ars/33/01133.html