What is the Chapter 7 bankruptcy process?

The Chapter 7 bankruptcy process is fairly straightforward. It involves the following steps:

Filing - The debtor files a voluntary petition or is the subject of an involuntary petition.

Bankruptcy Estate - Initiating the bankruptcy process creates the bankruptcy estate containing all of the debtors non-exempt assets. Also, the automatic stay halts all collection efforts against the debtor. The trustee in bankruptcy is appointed or elected and charged with identifying and assembling assets of the bankruptcy estate.

Proofs of Claim - At the time of filing, creditors of the debtor are put on notice of their rights to put in a claim against the bankruptcy estate for any debts owed them by the debtor. Secured creditors must be paid in full from the estate or have the property serving as collateral for the debt surrendered to them. Once secured creditors are paid to the extent of the value of their security interest in collateral, unsecured creditors are paid based upon their priority. Higher priority creditors will be paid before lower priority creditors. All creditors in a given class of debtor will be paid an equal percentage of their claims.

Liquidation - The trustee will sell or liquidate all available assets of the bankruptcy estate to generate funds to pay estate debts.

Discharge - Once all assets of the estate are liquidated and creditors paid, the court will enter an order discharging the debtor of all debts identified in the bankruptcy proceeding. Failure to submit a claim after receiving notice will cause a claim to be discharged. If a creditor is not notified of the bankruptcy proceeding, that creditors claim against the debtor will not be discharged.

This process is fairly linear in nature. It is common for bankruptcy cases to be dismissed at any stage of the proceeding for failing to move forward in accordance with the courts order.

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Discussion: What do you think about the process for filing a Chapter 7 Bankruptcy? Can you think of situations where a business liquidation could be very difficult? Do you think the process adequately protects creditor rights?

Practice Question: ABC Corp is in dire straits. It is considering filing for bankruptcy and liquidating the company. Can you explain to ABC the process of liquidating under Chapter 7?