Chapter 7, Liquidation, is an orderly, court-supervised procedure by which a trustee takes over the assets of the debtor’s estate, reduces them to cash, and makes distributions to creditors, subject to the rights of secured creditors and the debtor’s right to retain certain exempt property. In most Chapter 7 cases, the bankruptcy estate—the debtor’s legal interests at the beginning of the bankruptcy procedure—contains few possessions that can be sold to meet the debtor’s obligations. Due to this lack of non-exempt property, there may not be an actual liquidation of the debtor’s assets. These cases are called “no-asset cases.” A creditor holding an unsecured claim must file a proof of claim with the bankruptcy court and will receive a distribution from the bankruptcy estate only if the case is an asset case. In most Chapter 7 cases where the debtor is an individual, the debtor receives a discharge releasing them from personal liability for certain dischargeable debts. Normally, the discharge is received just a few months after the petition is filed.
A debtor’s eligibility for Chapter 7 or Chapter 13 is determined by a means test—an evaluation of the debtor’s ability to pay based on income and basic living expenses. Consumer debtors who do not qualify for Chapter 7 relief may be able to file under Chapter 13.
Chapter 13, adjustment of debts of an Individual With Regular Income, is designed for an individual debtor who has a regular source of income. It is often preferable to Chapter 7 because it enables the debtor to keep a valuable asset, such as a house, and because it allows the debtor to propose a “plan” to repay creditors over time—usually three to five years. At a confirmation hearing, the court either approves or disapproves the debtor’s repayment plan, depending on whether it meets the Bankruptcy Code’s requirements.