What Happens to Most of Your Debts in Chapter 7 “Straight Bankruptcy”?
Your debts that are not secured by collateral and are not “priority” debts are discharged (written off) and paid nothing. Mostly.
In my blog post last week I introduced the three main categories of debts: “secured,” “priority,” and “general unsecured.”
Secured and priority debts tend to be the ones with issues worth talking about. Secured debts often have liens against your important property and possessions—your home, your car or your truck, maybe your furniture and appliances. Priority debts are ones that are usually not secured but are favored in various ways in the law. They include child and spousal support, certain taxes, and such.
It’s worth paying a lot of attention to secured and priority debts because they raise questions that are likely important to you. Such as, how does bankruptcy help you keep your car if you are behind on payments? If you file a Chapter 7 case do you have to keep paying on your furniture loan to keep your bedroom furniture, and if so how much? How can filing bankruptcy enable you to get and/or keep current on your child support? Will you be able to write off any of your overdue income taxes?
We will look into these questions and more about secured and priority debts in upcoming blog posts. And yet, you probably have more of the third category of debts, “general unsecured” ones, than either secured or priority debts. So first let’s look at what happens to your general unsecured debts, covering today what happens if you file a Chapter 7, and then in my next blog post what happens under Chapter 13.
General Unsecured Debts
First a reminder from last week: general unsecured debts are those that don’t belong in the other two categories. They are unsecured in that they have no lien on any of your property or possessions. They are “general” simply in that they are not one of special “priority” debts that the law has selected for special favored treatment.
General unsecured debts include all sorts of obligations. Besides the most common ones like (most) credit cards and medical bills, they include personal loans without collateral, checking accounts with a negative balance, bounced checks, most payday loans, claims against you for property damage and personal injury, for breaches of contract—again, just about any way that you can owe money without collateral.
What Happens to Most General Unsecured Debts in Most Chapter 7 Cases
All these kinds of general unsecured debts are usually just legally, permanently written off—“discharged”—in a Chapter 7 bankruptcy case. That means that once they are discharged—usually about 3 months after your case is filed—the creditors can take absolutely no steps to collect those debts.
The only way those debts are paid anything is if either 1) the debt is NOT dischargeable or 2) it is paid (in part or in full) through an asset distribution in your Chapter 7 case.
A creditor can dispute your ability to get a discharge of your debt. Very few general unsecured debts are challenged and so they get discharged. In the rare case that the discharge of one of your debts is challenged, you may have to pay some or all of that particular debt. That depends on whether the creditor is able to establish that the facts fit within some quite narrow grounds. That would usually involving allegations of fraud, misrepresentation or other similar bad behavior on your part. If the creditor fails to establish the necessary grounds, the debt is discharged.
There are also some general unsecured debts that are not discharged unless you convince the court that they should be, such as student loans. The grounds for discharging student loans are quite difficult to establish.
2) Asset Distribution
If everything you own is exempt, or protected, then your Chapter 7 trustee will not take any of your assets from you. This is what usually happens—you’ll hear it referred to as a “no asset” case. But if the trustee DOES take possession of any of your assets for distribution to your creditors—an “asset case”— your “general unsecured creditors” may, but often don’t receive some of it. The trustee must first pay off any of your priority debts, as well as pay the trustee’s own fees and costs. The unsecured creditors get a pro rata share of the pool of whatever, if anything is left over.
In most Chapter 7 cases your general unsecured debts will all be discharged and most of the time will receive nothing from you. Rarely, a creditor may challenge the discharge of its debt. And if, again rarely, you have an “asset case,” the trustee may pay a part or—extremely rarely—all of the general unsecured debts, but only after paying all priority debts and his or her fees and costs.