For the 12-month period ending September 30, 2010, approximately 1.6 million bankruptcy cases were filed in U.S. federal courts. More than 1.5 million of those cases were non-business filings, with the majority falling under Chapter 7 of the Bankruptcy Code. The primary goal of a Chapter 7 filing, also referred to as a liquidation case, is to secure a bankruptcy discharge, which relieves the individual from all or most of his or her debts (often excluding secured auto and mortgage loans). In other words, the debtor is essentially given a "fresh start."
Although most Chapter 7 cases are filed by wage earners or unemployed individuals with unsecured consumer debts (typically credit cards and medical expenses), the recent economic crisis has made bankruptcy a reality for the rich and famous. To provide additional context, since the summer of 2008, more than 5 million jobs have been lost in the United States and trillions of dollars in stock and real estate wealth have simply vanished. This significant loss of wealth has created severe financial distress and resulted in an increase in Chapter 7 filings by individuals who had no prior history of late or missed loan payments, had no experience with potential liability on a guaranty and had never been contacted by a workout officer to discuss a bank loan in default. Within a short period of time, many individuals saw their balance sheets shift from positive net worth of seven figures to negative net worth of seven figures. Unfortunately, the only way for many of those individuals to obtain relief from debt was to file a Chapter 7 liquidation case.
Anatomy of a Chapter 7 Filing
Most of the debt in a Chapter 7 case filed by previously high-net-worth individuals is business-related, as opposed to consumer debt. Many cases involve defaulted loans caused by failed investments and business ventures related to real estate. Prior to filing their Chapter 7 cases, many of those individuals were defendants in lawsuits initiated by creditors trying to collect debts or foreclose mortgages or other security interests. The filing of a Chapter 7 case imposes an automatic stay, which prevents creditors from initiating or continuing collection efforts against the debtor, thus providing a reprieve from the associated cost and anguish.
Once a Chapter 7 case has been filed, the bankruptcy court appoints a trustee, who has the power to liquidate non-exempt assets and distribute the proceeds to creditors. Initially, the trustee reviews the debtor's schedules and statement of financial affairs to determine if there are assets that have a value in excess of available exemptions. In Illinois, each individual who files a bankruptcy case is entitled to keep certain property claimed as exempt. Examples of Illinois exemptions available to each individual in a Chapter 7 case include the following:
- $15,000 of equity in a personal residence ($30,000 for a husband and wife)
- $2,400 of equity in a motor vehicle for each individual owner
- Payment, not to exceed $15,000, on account of personal bodily injury
- $4,000 of equity in any other property
- Necessary wearing apparel, bibles, school books and family pictures
- $1,500 of equity in tools of the trade or professional books
- Retirement, Social Security, public assistance, unemployment, veterans and other benefits
Although it is extremely unusual for the debtor in a typical consumer Chapter 7 case to have any non-exempt assets, that may not be true when significant business debt and higher-valued assets are involved. In these instances, the trustee will more closely scrutinize the debtor's scheduled assets, the value ascribed to those assets and the claimed exemptions. In most instances, there is still no non-exempt equity in real estate due to a decline in property values or because the real estate has already been pledged as additional collateral for business-related debt. However, individuals with higher-valued assets might own a motor vehicle free and clear of liens, or furniture and other household goods with a value that exceeds exemption amounts. If a Chapter 7 trustee determines there are non-exempt assets that can be liquidated, the trustee may sell them, but not without first receiving court approval.
The benefits of receiving a bankruptcy discharge far outweigh the negatives, but it is important to acknowledge a few potential downsides. For example, an individual with higher-valued assets might not be allowed to claim all of those assets as exempt, thus leaving a portion exposed to liquidation. Further, an individual can only receive a Chapter 7 discharge every eight years. Also, the filing of a Chapter 7 case will limit an individual's ability to obtain credit in the future, although the effect varies from person to person.
Ultimately, those individuals who, due to the economic crisis, went from living a lifestyle of the rich and famous to a life of financial distress can benefit from filing a Chapter 7 bankruptcy case. After all, under the Bankruptcy Code, everyone is entitled to receive a "fresh start."© 2013 Much Shelist, P.C.