Chapter 7 “asset” cases may sound scary. They needn’t be. We walk you through a very straightforward example to demystify this.
Asset and No-Asset Chapter 7 Cases
Our last blog post discussed the difference between a no-asset and asset Chapter 7 case. Simply put, in a no-asset case everything you own is covered and protected by available property exemptions. So your trustee takes nothing from you. In contrast, in an asset case, something you own is not covered by a property exemption. So the trustee takes it, sells (“liquidates”) it, and distributes the proceeds to your creditors.
We ended our last blog post with a short example of what happens in an asset case if you happen to owe certain kinds of debt that you’d still have to pay after bankruptcy, such as accrued child support or recent income taxes. The Chapter 7 trustee pays such special “priority” debts in full before paying anything on ordinary debts. That way most of your asset proceeds go to a debt that you have to pay anyway.
But what if you don’t have any such priority debts? What happens in an otherwise simple Chapter 7 case in which you to have an asset that the trustee gets and liquidates?
Our Simple Example
Assume someone named Hannah owes $80,000 in a combination of personal loans, credit cards, and medical bills. Her income qualifies her for a Chapter 7 case under the “means test” in her state with her family size. Under the property exemptions that the law provides to her, everything she owns is exempt except for one thing. She owns, free and clear, a sailboat with a fair market value of $8,000. (Such a boat may be exempt in some states, probably depending on what else she owns, but let’s assume it’s not exempt here.)
Hannah would partly like to keep the boat, because her kids enjoy sailing with her. But it is quite expensive to maintain, draining money she needs for much more important expenses. So she doesn’t terribly mind losing the boat.
Keeping the Boat
Her bankruptcy lawyer tells Hannah she does have two possible ways to keep the boat. One is under Chapter 7 “straight bankruptcy” and another under Chapter 13 “adjustment of debts.”
She could likely keep the boat by essentially paying for the right to keep it, in a different way with these two options.
Chapter 7 Option for Keeping the Boat
In a Chapter 7 case, if she could come up with around $8,000 she could offer it to the trustee. The trustee would almost certainly accept the money instead of taking the boat. In fact the trustee would likely accept somewhat less because Hannah would be saving the trustee the costs involved in liquidating the boat. The trustee may even allow Hannah to pay off the boat over the course of several months. Then after receiving Hannah’s money, the trustee would distribute it out to her creditors.
Assuming that Hannah doesn’t have ready access to $8,000, either immediately or over the next several months, this is not a very practical option. And even if she could borrow or otherwise raise the money, she’d likely decide that that much effort wasn’t worthwhile. Again, she doesn’t really want the boat anymore.
Chapter 13 Option for Keeping the Boat
Chapter 13 makes hanging onto the boat easier. Hannah would likely have 3 to 5 years to make payments into a Chapter 13 payment plan. Those payments would reflect how much she could afford to pay, and would have to be enough over time to pay at least the $8,000 value of the boat.
So she’d have much more time to pay than under Chapter 7. But she’d be stuck in a bankruptcy case for years, simply to be able to keep something she no longer thinks is wise to keep.
The Best Option Here—the Asset Chapter 7 Case
Hannah decides that simply giving the boat to the Chapter 7 trustee would be the best for her here.
So, with the help of her lawyer she files a Chapter 7 case. A few weeks later she signs over the boat to her assigned trustee. The trustee sells the boat, and after expenses (for the boat broker’s commission, storage fees and such), has a net amount of $7,000.
The trustee is entitled to a fee. It’s generally calculated to be no more than 25% of the first $5,000 distributed, plus 10% of the next $45,000. (See Section 326(a) of the U.S. Bankruptcy Code.) That amounts to a $1,950 fee here, which would come out of the $7,000.
That leaves $5,050 for the creditors. Since Hannah owes no “priority debts,” the $5,050 is divided pro rata among the $80,000 of debts. This means that her creditors would all receive a little more than 6 cents on the dollar.
Although Hannah is losing the boat to her creditors, under her circumstances this is her best option. She gets rid of something that she doesn’t need, finishes her case in a matter of a few months, and gets a fresh financial start by being debt-free.