What it means
The defining feature of Chapter 7 is that it looks at what the debtor owns today rather than what they might earn tomorrow. A trustee is appointed, takes control of the estate, sells anything not protected by exemptions, and pays out the proceeds according to statutory priority before the case is closed.
Exemptions are what stop most individual cases from being ruinous. State and federal rules protect a defined amount of home equity, a vehicle, household goods, tools of trade and retirement savings, and in a large share of consumer cases there are no non-exempt assets at all, so unsecured creditors receive nothing.
Individuals must pass a means test based on income relative to the median for their household size and state. Someone earning well above that median is generally steered towards Chapter 13 instead, on the reasoning that they have enough surplus income to repay something over time.
The distribution order matters enormously to creditors. Secured creditors look first to their collateral, then administrative and trustee costs are paid, then priority claims such as certain taxes and unpaid wages, and only then do general unsecured creditors share whatever is left, usually receiving cents on the dollar or nothing.
Not everything is wiped out. Debts such as most student loans, recent tax liabilities, child support, alimony and liabilities arising from fraud generally survive a Chapter 7 discharge, and secured lenders can still repossess collateral if the debtor does not keep paying for it.
For a company, Chapter 7 is the end rather than a restructuring. The business ceases operations, employees are let go, assets are sold, and there is no discharge for a corporate entity because the entity simply stops existing once the case concludes.
In practice
Real-world examples.
Example
An individual with $52,000 of credit card debt, a leased car and almost no equity in anything files under Chapter 7. The trustee finds no non-exempt assets, the case closes in about four months, and the credit card balances are discharged with creditors receiving nothing.
Example
A failed restaurant company files under Chapter 7 rather than attempting a rescue. Kitchen equipment and a liquor licence are sold by the trustee, staff wage arrears are paid as priority claims, and food suppliers holding unsecured invoices recover a small fraction of what they were owed.
Example
A regional wholesaler learns that one of its retail customers has filed under Chapter 7 owing $17,000. The credit team writes the balance off in full immediately, because the notice states the case is a no-asset case with no distribution expected.
Formula
Calculation
Distribution to unsecured creditors = proceeds from non-exempt assets - administrative and trustee costs - priority claims, and recovery rate = distribution / total unsecured claims
A trustee sells the non-exempt assets of a failed retail business for $120,000. Administrative and trustee costs, including legal fees and the cost of running the sale, come to $18,000, leaving $120,000 - $18,000 = $102,000. Priority claims for unpaid employee wages and recent taxes total $22,000 and are paid in full, leaving $102,000 - $22,000 = $80,000 for general unsecured creditors. Those creditors have claims totalling $400,000, so the recovery rate is $80,000 / $400,000 = 20%, meaning a supplier owed $30,000 receives $30,000 x 0.20 = $6,000 and writes off the remaining $24,000.Case study
Seen in the real world.
Copperlane Textiles is an illustrative and clearly fictional fabric wholesaler created to show how Chapter 7 plays out for an unsecured supplier. It was owed $64,000 by a chain of three clothing shops that had been slowing its payments for six months.
When the chain filed under Chapter 7, Copperlane's exposure was entirely unsecured and behind a bank that held a charge over inventory and receivables. The trustee's eventual distribution to general unsecured creditors was 11 cents on the dollar, so Copperlane received $64,000 x 0.11 = $7,040 nearly two years after the filing and wrote off $56,960.
In this illustrative case the loss was survivable but the lesson was expensive. Copperlane introduced a rule that any account slowing beyond forty-five days moved to pro forma terms, and it began checking whether large customers had granted an all-assets charge to a lender, since that determines where a supplier stands in the queue.
Watch out
Common mistakes.
- Assuming Chapter 7 clears every debt, when tax arrears, child support, alimony, most student loans and fraud-related liabilities normally survive the discharge.
- Believing a filer loses everything, when exemptions protect a defined amount of home equity, a vehicle, tools of trade and retirement savings in most cases.
- As a supplier, continuing to chase a balance after a filing notice arrives, which breaches the automatic stay and can expose the creditor to sanctions.
Questions
People also ask.
How long does a Chapter 7 case take?
A straightforward individual case usually completes in around three to six months, far quicker than the three to five years of a Chapter 13 plan.
What do unsecured creditors typically receive?
Often nothing, because many consumer cases are no-asset cases, and where there are assets the recovery is usually a small percentage after secured and priority claims are settled.
Can a business use Chapter 7?
Yes, but it means liquidation rather than rescue, so the company stops trading, its assets are sold and it does not receive a discharge because the entity ceases to exist.
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