Liquidation bankruptcy—also referred to as “ordinary,” “straight,” or “Chapter 7” bankruptcy—is the most commonly filed bankruptcy type for individuals. The term liquidation bankruptcy comes from the fact that the bankruptcy trustee assigned to the case sells or “liquidates” property for the benefit of creditors.
To learn more about liquidation bankruptcy, see Chapter 7 Bankruptcy.
You’ll start your bankruptcy case by filing a set of official bankruptcy forms. In those forms, you’ll list information regarding your financial state, including all of the property you own.
You don’t lose everything in bankruptcy, however. You’ll get to keep—or exempt—property necessary to maintain a home and job (more below). Learn about the Chapter 7 bankruptcy process.
Exemption laws list the type and amount of property you can protect in bankruptcy. Your state decides the property its residents can protect in any type of bankruptcy, including in a liquidation case. One of the important considerations when deciding whether to file for bankruptcy is determining whether the available bankruptcy exemptions will adequately protect your assets.
You’ll list the law that allows you to exempt each asset on Schedule C: The Property You Claim as Exempt (individuals). The form is available on the U.S. Court’s bankruptcy form website.
The trustee will review all of your bankruptcy forms, including Schedule C. If you don’t have any property that the trustee can sell, your creditors will be informed that your case is a “no-asset” bankruptcy case and that there is no need to submit a proof of claim form for payment.
If you have nonexempt property that the trustee can liquidate, creditors will be given a date by which they must file a proof of claim. The trustee will sell any nonexempt assets and distribute the sales proceeds to unsecured creditors. Secured debt is backed by collateral, like a home or car, whereas unsecured debt is not.
The trustee will pay creditors according to the priority payment rules. The priority rules allow some debt to go to the head of the line, for instance, domestic support arrearages and recent tax debt.
Chapter 7 liquidation bankruptcy is meant for low-income filers who don’t have sufficient income to repay creditors. By contrast, Chapter 13 reorganization bankruptcy provides income earners a way to repay creditors an affordable amount over time.
In many cases, Chapter 7 filers have little property to relinquish. They’ve often already converted any nonexempt property in an attempt to avoid bankruptcy. For instance, luxury items like boats or recreational vehicles are usually sold and the proceeds used for necessary living expenses before filing.
One exception is home equity, however. With home values on the rise, some filers find that the homestead exemption doesn’t cover all of the equity in their house. In that case, the trustee would sell the home, pay off any mortgages, return the exempt portion to the homeowner, and distribute any remaining funds to creditors.