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Will I Lose Some of My Assets if I File for Chapter 7?

Under Chapter 7, you might well have to turn over many, if not all, of your nonexempt assets. What happens depends upon the classification of the asset:

Assets pledged as collateral on a loan (encumbered assets). When you have borrowed to buy a car, boat, household furniture, appliance, or other durable item, the lender commonly has a lien (legal claim) on that property to secure the debt until the loan is fully repaid. You may also have given a lien on property you already owned to obtain a new loan, such as a second mortgage to finance home improvements. Some creditors may obtain liens without the debtor's agreement, either because they have won a lawsuit against the debtor or because the law automatically provides a lien for certain claims, such as for duly assessed taxes.

In bankruptcy a claim is "secured" to the extent that it is backed up by collateral. Often the collateral is worth less than the amount of the debt it secures, such as a $1200 car securing a loan balance of $3000. In that case, the lender is "undersecured" and is treated as holding two claims, a $1200 secured claim and an $1800 unsecured claim. On the other hand, sometimes a debt is secured by collateral whose value exceeds the loan balance at the time of bankruptcy, such as a $65,000 home subject to a $30,000 mortgage. In that case, the lender is "oversecured." The lender is entitled to no more than the $30,000 it is owed. The excess value of $35,000 is referred to as the debtor's "equity."

If you cannot make the required payments on a secured claim (and also catch up on any back payments), the creditor has a right to take back the collateral after having the automatic stay lifted. However, you may be able to keep your car, boat, or other durable item by redeeming it or reaffirming your debt (as explained later in this chapter) or by continuing to make payments.

Unencumbered assets. For present purposes, these include (1) assets on which there is no lien at all and (2) the debtor's equity in assets that are collateral for oversecured claims. The debtor retains unencumbered assets to the extent that they are exempt; otherwise they must be surrendered for distribution among those holding unsecured claims.

Exempt assets. These are assets that you must list on your Statement of Financial Affairs and schedules and that you may shield from your unsecured creditors. The assets that you may protect in this way are defined by federal and state law. In about fifteen states you may chose either of the two laws, while in most states you may use only the state exemptions. Exemptions vary widely. For example, under the federal statute a couple filing jointly may exempt a total of $32,300 in equity in their home, $16,500 for each of them. Thus, if the home is worth $65,000 and has a $30,000 mortgage, creditors can claim only $2,700 (the difference between the equity of $35,000 and the $32,300 exemption). As a matter of practice, the couple would probably keep their home-perhaps at the cost of paying that $2700 in nonexempt equity to the trustee-rather than have it sold for the benefit of the creditors.

In contrast, Florida allows a homestead exemption that protects from creditors a debtor's home and property so long as it does not exceed half an acre in a municipality or 160 acres elsewhere. Thus, an investment banker who filed bankruptcy has been able to retain a beachfront home reportedly valued at $3.25 million. In Georgia the homestead exemption is limited to $5,000. Similar variations among the states are found concerning a broad array of other exempt assets such as autos, jewelry, household furnishings, books and tools of the debtor's trade.

Congress has recently been considering proposals to introduce greater nationwide uniformity in exemptions, including a dollar cap on the most generous state homestead provisions.

In cases involving an individual married debtor or joint debtors, several specific points about exemptions are worth noting. First, in joint cases, each spouse must claim exemptions under the same law, either both relying on state law or both relying on federal law. Second, when federal exemptions are elected and often as well when state law applies, each spouse can claim the full exempt amount on his or her own behalf, as illustrated above with the doubling of the federal homestead exemption. In questionable decisions, however, some courts have followed state law in limiting joint debtors to only a single set of state law exemptions. Third, in more than fifteen states, creditors of only one spouse are barred either completely or in large part from reaching real and/or personal property owned by the debtor with a non-debtor spouse as joint tenants or tenants by the entirety. Those bars generally apply in any bankruptcy case where state law exemptions govern.

Finally, as mentioned above, exempt assets are beyond the reach of unsecured creditors. Exemptions do not ordinarily affect the rights of creditors with respect to assets on which they have liens. For example, homestead exemptions generally do not affect the rights of a mortgage lender to foreclose on the debtor's home. Under some specific circumstances, the Bankruptcy Code may permit the debtor to undo a lien and then assert exemption rights. This is a matter about which it is probably best to consult an attorney.

Nonexempt unencumbered assets. The Bankruptcy Code requires that you give all these nonexempt assets to the bankruptcy trustee. The trustee will then liquidate (sell off) these nonexempt assets for the benefit of your creditors. However, in actual practice, over 85 percent of Chapter 7 filings are "no-asset filings"-that is, there are no assets left for unsecured creditors after the exempt assets have been claimed.

Family Legal Guide Copyright © 2000, 2002 American Bar Association