How Chapter 7 Bankruptcy Works for Debtors and Creditors

One of the most misunderstood topics in the financial world is how chapter 7 bankruptcy works for debtors and creditors. Unfortunately, this misunderstanding is not minor (like one of those passionate debates about whether the 1927 New York Yankees were statistically the best baseball team of all time, etc.). On the contrary, confusion around how chapter 7 bankruptcy impacts debtors and creditors is costly and stressful. 

How Bankruptcy Works for Debtors

Filing for chapter 7 bankruptcy (a.k.a. “liquidation bankruptcy”) will essentially wipe out most debts that were incurred prior to the filing (exceptions include child support obligations, court-ordered restitution, etc.). All non-exempt property, such as savings that are not part of a registered retirement vehicle, will be transferred to the court-appointed bankruptcy trustee, who undertakes a structured and transparent liquidation process. Proceeds are then distributed to creditors based on a pre-set amount (e.g. $0.50 for every $1 owed, etc.).

How Bankruptcy Works for Creditors

Once a filing is made, all creditors must immediately cease all collection activity, including wage garnishment. Note that it may take a couple of weeks for the court to notify all creditors of the filing, but debtors can have their lawyer contact creditors on their behalf to cease activity.  

Of extreme importance: once a bankruptcy filing has been received by the courts, creditors may not under any circumstances contact debtors directly. All correspondence, including claims and objections to distributions (i.e. how much money they will get when assets liquidated) must be made to the bankruptcy trustee.

The Role of the Bankruptcy Trustee

A major source of confusion regarding chapter 7 bankruptcy is the role of the bankruptcy trustee. This individual, who typically is part of a firm that specializes in this area, does NOT work for either debtors or creditors. They are also not mediators, arbitrators or negotiators who have any interest in ensuring that both sides reach a mutually acceptable solution.

Bankruptcy trustees have one clear function: to ensure that the bankruptcy process is managed and governed appropriately and legally, and if necessary to provide evidence of such to the court (which may be demanded by debtors, creditors or the court itself). In other words, bankruptcy trustees are beholden to the law. They have no interest — legally, financially or morally — in seeing one party benefit vs. another. The process is what matters: not the parties themselves.

The Role of a Bankruptcy Attorney

Another key misunderstanding relates to the role of a bankruptcy attorney. In light of the above, some debtors may believe — rather mistakenly — that the process will be straightforward, and therefore, safe (financially speaking).

However, bankruptcy trustees and judges can make mistakes (they are human beings after all, and some issues are somewhat interpretive rather than black-and-white), and more problematically, some creditors do not follow the rules. A bankruptcy attorney will ensure that creditors behave properly, and debtors are safeguarded; often by reminding creditors that bankruptcy, as a legal mechanism, fundamentally exists to PROTECT debtors — not to serve creditors (which is why it is filed by debtors). 

Simply put, the value of an experienced bankruptcy attorney cannot be underestimated; especially considering that the vast majority of debtors who file for bankruptcy are at a major knowledge disadvantage: everyone else — including creditors — knows more about bankruptcy law and protocol than they do, even though they are the ones who face the greatest long-term financial risk.

Learn More

To learn more about what you need to know about filing for chapter 7 bankruptcy — and to ensure that you know what the road ahead may look like if you proceed — contact the Law Office of Charles H. Huber today.