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    Representing Chapter 7 Bankruptcy Debtors: Going for Broke

    There are a myriad of considerations that may enter into a decision to file a bankruptcy. However, for the run-of-the-mill consumer debtor, there are usually only a few.

    James McNeilly Jr

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    Wisconsin Lawyer
    Vol. 77, No. 11, November 2004

    Representing Chapter 7 Bankruptcy Debtors:
    Going for Broke

    Bankruptcy is a unique practice area with its own language and procedures not found elsewhere in the law. With Chapter 7 consumer bankruptcies on the rise, more lawyers will be called on to represent debtors in these procedures. This article assists general practitioners in representing typical Chapter 7 consumer debtors.


    hands reachingby James W. McNeilly Jr.

    Chapter 7 bankruptcy proceeding filings in the Western District of Wisconsin have increased from fewer than 3,000 cases per year in 1989 to approximately 6,500 cases per year in 2001.1 In the Eastern District, Chapter 7 filings went from 5,475 in 1989 to 11,911 in 2001.2 In 2003, nonbusiness bankruptcy filings outnumbered business filings nationally 1,625,208 to 35,037.3 This trend suggests that more lawyers may be asked to assist their clients in filing Chapter 7 bankruptcies. This article is directed at assisting general practitioners in representing typical Chapter 7 consumer debtors. Unusual or complex situations, such as a married debtor filing singly, prebankruptcy planning, or adversary proceedings, are not covered.

    Chapter 7 Basics

    Chapter 7 bankruptcies, sometimes called "straight bankruptcies" or "liquidations," are what most nonlawyers think of when they think of bankruptcy. The purpose of a Chapter 7 is the release of personal liability for debts, called a "discharge."

    According to one theory, the word "bankruptcy" is derived from the medieval Italian words meaning "broken bench." The merchants of the time sold their wares in the marketplace on benches. If a merchant could not pay his debts, creditors would seize and liquidate all of the merchant's assets, dividing the proceeds among themselves. Then, they would break the merchant's bench, presumably to prevent the now "bankrupt" merchant from reopening.

    Theoretically, a similar process occurs in a modern Chapter 7 bankruptcy. The debtor declares bankruptcy, his or her assets are seized and liquidated, and the proceeds are divided among the creditors. Unlike in medieval times, the debtor today receives a discharge of personal liability on all dischargeable debts.

    In actual practice, the debtor keeps all of the debtor's property in virtually all consumer Chapter 7 bankruptcies. The debtor has the right to protect certain assets, called "exemptions," because the property is exempt from being liquidated to pay debts. However, the bankruptcy does not discharge liens on the debtor's property unless certain procedures are followed and only then in specific circumstances. The debtor may retain assets subject to liens, provided 1) there is little or no equity in the property that cannot be exempted and 2) the debtor pays the secured debt. Most debtors do not own any property that is either not subject to liens or is exempt. As a result, the only event of consequence in most consumer Chapter 7 bankruptcies is the discharge of debts. These cases are known as "no asset" or "no distribution" cases. The debtor's ability to receive a discharge does not depend on whether the case is a no distribution case or, its opposite, an "asset case."

    Most debtors are entitled to a discharge,4 and most debts are dischargeable.5 The debts that are not dischargeable are specified. Some debts, such as certain taxes, are simply deemed nondischargeable. Other debts can be determined to be nondischargeable only if a creditor prevails in objecting to the discharge of that particular debt. The debtor can be denied a discharge of all debts under certain circumstances.6 Objections to the debtor's discharge or to the discharge of a particular debt must be brought by filing an adversary proceeding. Adversary proceedings are lawsuits brought in connection with the bankruptcy. The Bankruptcy Code - 11 U.S.C. sections 101-1330 and the Federal Rules of Bankruptcy Procedure, collectively, the "Code" - provides a 60-day period, which runs from the date of the creditors' meeting, in which to file an objection to discharge.7 Under 11 U.S.C. section 727(d), a discharge also may be revoked under certain circumstances (usually because the debtor committed fraud in connection with the case or did not cooperate with the administration of the case).

    If the case is a no asset case, and no objection to the discharge is filed, the debtor receives the discharge and the case is closed.

    Attorney Fees

    A full discussion of attorney fees is beyond the scope of this article. At a minimum, however, readers should be aware of a recent Seventh Circuit decision, Bethea v. Robert J. Adams & Associates,8 in which the court held that there are only two lawful attorney fee arrangements when representing a debtor in a Chapter 7 bankruptcy: 1) full payment before the bankruptcy is filed; or 2) full payment for the services performed before the filing, with a separate agreement, which must be entered into after the filing, for services performed after the filing.

    Unfortunately, there are legal, ethical, and practical problems with both types of fee agreements, and practitioners are struggling with how to handle attorney fees in Chapter 7 cases.

    Petition, Schedules, and Statement of Financial Affairs

    A Chapter 7 bankruptcy proceeding is commenced when the petition - a formal request for relief under the Bankruptcy Code - is filed. When the petition is filed, an order for relief is invariably issued in a voluntary case. The debtor also must file schedules and a statement of financial affairs (collectively referred to as "the schedules"). While the schedules often are filed with the petition, an "emergency filing," consisting of the petition and minimal other documents, may be used to commence the case and trigger the automatic stay (defined below).

    An emergency filing is important when the debtor needs the automatic stay imposed as soon as possible - for example, when the debtor's wages are being garnished. The remaining schedules must be filed within 15 days, unless an extension is granted on motion.9 Because the debtor signs the schedules under oath, incorrect or misleading information can result in a denial or revocation of the debtor's discharge and criminal prosecution.10 The schedules must be filed on official forms.11 The documents may be filed on paper or electronically. The forms can be obtained from numerous sources such as the Wisconsin State Law Library, on the Web, and from various bankruptcy software providers.12

    The schedules divide debts into categories: secured, unsecured priority, and unsecured. Secured debts are obligations secured by liens on property. Unsecured priority debts are specific classes of debts given priority by the Bankruptcy Code. Unsecured debts are the remainder. The debtor claims exemptions on Schedule C. In Wisconsin, debtors have the choice of using the Wisconsin statutory exemptions, contained primarily at Wis. Stat. sections 815.18 and 815.20, or the federal exemptions at 11 U.S.C. section 522. The debtor must choose between the state and federal exemptions. The trustee and creditors have 30 days from the date of the creditors' meeting or from the date of an amended Schedule C filing, whichever is later, to object to the claimed exemptions.13

    The statement of financial affairs is a series of questions that assist the trustee, creditors, and the court in discovering nonexempt, unsecured assets, preferences, and fraudulent transfers, and in determining whether grounds exist to deny the debtor's discharge or to bring a motion to dismiss the case based on substantial abuse. "Substantial abuse" is defined later in this article.

    The schedules (except for the statement of intentions) may be amended at any time before the case closes.14 However, courts will sometimes not allow an amendment to be made to Schedule C after the trustee has begun to administer an asset. "Administer" means to liquidate the asset for the benefit of creditors.

    Proper Techniques for Preparing the Schedules

    It is more efficient and cost-effective for the attorney and the client if the debtor is responsible for obtaining the information necessary to prepare the schedules. For the same reason, many firms use paralegals to help prepare the schedules, under attorney supervision. To ensure that all relevant facts in all cases are captured, it is absolutely necessary for the attorney to meet with the debtor at least once to thoroughly review the schedules before filing.

    The most common error in preparing schedules is the improper investigation of the perfection of security interests. The ability of the trustee to make use of the trustee's "avoiding powers" (discussed below) often depends on whether a security interest is properly perfected. For this reason, the local rules for both the Eastern and Western Districts of Wisconsin require that information demonstrating the perfection of security interests (such as mortgage recording) be contained in the schedules or provided to the trustee. The attorney must obtain and examine this information to verify whether the security interests are perfected so that the debtor can be properly advised as to the effect of the bankruptcy. For example, Wis. Stat. section 706.02(1)(f) requires a nonpurchase money mortgage secured by a homestead to be signed by both spouses. (Nonpurchase money means that the loan proceeds were not used to buy the property securing the loan.) In some instances, such mortgages were not signed by both spouses. In other cases, the notes and mortgages, while properly executed, were not recorded. In such situations, the trustee may be able to avoid the mortgage and, unless the debtor can exempt the resulting equity, the property likely will be sold. Even though the debtor is entitled to the debtor's homestead exemption, the debtor is not likely to be happy about losing the homestead.

    Automatic Stay

    On filing the petition, virtually all actions (including, most importantly, collection actions) against the debtor and the debtor's property are enjoined by the automatic stay.15 The stay is called "automatic" because it is effective immediately when the petition is filed without any other action, and because it is effective even against creditors who have no knowledge of the bankruptcy filing.

    With certain extremely rare exceptions, the stay terminates under the following circumstances. A stay that enjoins actions that do not involve "property of the estate" (defined below) terminates when the debtor receives a discharge, or sooner, if a creditor prevails on a motion for relief from stay. When a stay that bars actions against the debtor's property terminates depends on whether the case is a no asset or an asset case. In a no asset or no distribution case, the stay terminates when the trustee files a "no distribution report" (effectively, an "abandonment" of the property) or when the debtor receives a discharge, whichever is later. In asset cases the stay terminates only if 1) a creditor brings and prevails on a motion for relief from stay and forces the trustee to abandon the property that is the subject of the motion; or 2) the debtor has received a discharge and the trustee abandons the property on the trustee's own initiative. Abandonment is dealt with later in this article.

    Creditors usually do not bring relief from stay motions in Chapter 7 actions because by the time a hearing on a motion can be held, the stay has already terminated due to receipt of the discharge or filing of the no distribution report. Debtors' attorneys rarely need to deal with such motions because: 1) most relief from stay motions are made by secured creditors seeking to proceed with foreclosure or replevin actions; and 2) most Chapter 7 debtors are either current on their vehicle and home loans and thus are not subject to such a motion or have no defense to the motion because they are hopelessly behind in payments and have little equity in the collateral.

    Bankruptcy Estate

    In a Chapter 7 bankruptcy proceeding, virtually all of the debtor's assets become the property of the bankruptcy estate (commonly called the "estate") immediately when the bankruptcy is filed.16 Those assets remain in the trustee's legal control and are subject to being sold for the benefit of creditors until they are properly exempted17 or the trustee abandons them. The trustee may abandon an asset either formally or by failing to administer the asset before the case is closed.18 A trustee is appointed by the U.S. Trustee's office (usually from the Chapter 7 panel)19 or, rarely, is elected by the creditors.20 The trustee performs an investigation, which has several purposes. The main purpose is to determine whether there are any unsecured, nonexempt assets or any assets recoverable pursuant to the trustee's numerous avoiding powers, which are set forth in the Bankruptcy Code. If the trustee recovers assets, the trustee liquidates those assets and distributes the proceeds according to the priority scheme contained in the Bankruptcy Code.

    The most common avoiding powers are the powers to recover fraudulent transfers and preferential payments. Fraudulent transfers are, generally, certain types of transfers by the debtor before filing that result in diminution of the bankruptcy estate.21 The term "fraudulent transfer" is somewhat of a misnomer, because some types of transfers qualify as fraudulent transfers even though there is no element of fraud. Most often, fraudulent transfers are conveyances to insiders22 (generally, members of the debtor's family) for less than full consideration or no consideration, made within one year before filing the bankruptcy petition. The trustee has the power to avoid these transfers and recover the assets for the creditors' benefit.

    Preferences, which are governed by 11 U.S.C. section 547, can take many forms, but usually are payments on unsecured debts. As noted above, theoretically, the trustee gathers the debtor's assets, liquidates them, and then divides the proceeds among creditors. Common sense dictates that a debtor is insolvent before the actual filing. The creators of the Bankruptcy Code decided it would be more fair if the Code provided a "lookback" period during which payments on debts to some creditors could be recovered by the trustee and distributed to all creditors. These payments are called preferences because the creditors receiving such payments are being "preferred" by the debtor. The lookback periods are 90 days from the date of filing for payments to creditors who are not insiders and one year for payments to insiders.

    James W. 
McNeilly Jr.James W. McNeilly Jr., U.W. 1981, practices in La Crosse and focuses in the areas of real estate, creditor-debtor, and estate planning. He has been a Chapter 7 panel trustee in the Western District of Wisconsin since 1987 and has administered thousands of Chapter 7 bankruptcies.

    Bankruptcy Code Section 341 Meeting

    The meeting of creditors is held not less than 20 and not more than 60 days after the order for relief is filed. This meeting is also called the "Section 341 meeting," after the Bankruptcy Code section governing the meeting. The trustee presides at this meeting. The trustee and creditors question the debtor about the schedules and the debtor's financial dealings. This is not a formal court proceeding and the trustee cannot rule on objections.

    Secured Consumer Debts

    Many debtors have consumer debts secured by collateral, such as vehicles, that they desire to retain. Additionally, some credit card agreements grant security interests in goods purchased with the credit card, such as household appliances and the like. Consumer debtors have several options by which they may retain these assets.

    Debts secured by nonpossessory, nonpurchase money liens in certain assets may be avoided pursuant to 11 U.S.C. section 522(f)(1)(B). Nonpossessory means the creditor does not have possession of the collateral.

    Debtors also have the right, pursuant to 11 U.S.C. section 722, to "redeem tangible personal property intended primarily for personal, family, or household use, from a lien securing a dischargeable consumer debt, if such property is exempted ... by paying the holder of such lien the amount of the allowed secured claim." The allowed secured claim is, in effect, the value of the collateral.23 For example, a debtor who owes $1,500 secured by a purchase money lien on a computer worth $300 can pay the creditor the $300 value in cash, keep the computer, and discharge the remaining amount of the obligation.

    If a debtor is unable to either avoid the lien or redeem the value, the debtor may reaffirm (agree to pay the debt) within the deadlines set forth in 11 U.S.C. section 521(2). 11 U.S.C. section 524(c) outlines the requirements for both the terms and execution of these reaffirmation agreements.

    Substantial Abuse

    More high-income debtors are filing Chapter 7 bankruptcies. 11 U.S.C. section 707(b) provides in pertinent part: "After notice and a hearing, the court ... may dismiss a case filed by an individual debtor under [Chapter 7] whose debts are primarily consumer debts if it finds that the granting of relief would be a substantial abuse." The potential for substantial abuse has been found in situations in which the debtor has the ability to pay a substantial portion of the debts, and is the reason for bankruptcy schedules I and J, income and expenses. Attorneys must carefully question debtors about their income and expenses, because many debtors do not accurately complete schedules I and J. It is wise to ask for pay stubs and checkbook ledgers to substantiate the debtor's income and expenses.

    Duty to Disclose

    Concealing, destroying, falsifying, or failing to keep records can be grounds to deny a debtor's discharge, as can failing to explain any loss or deficiency of assets.24 These provisions make it imperative for a debtor to be thorough in completing the schedules and, most especially, the statement of financial affairs. The statement consists of numerous questions, many of which deal with transfers and transactions. Transactions with relatives are very closely examined, because of the opportunity for the debtor to conceal assets by transferring them to a relative with the understanding that the assets will be transferred back after the filing. The debtor must fully disclose all such transfers and transactions or face a possible objection to the debtor's discharge. All bankruptcy practitioners must advise: disclose, disclose, disclose.

    Dealing with the Trustee

    Chapter 7 trustees have broad powers. Trustees often make inquiries of debtors to assist them in exercising those powers. The debtor has an affirmative duty to cooperate with the trustee.25 The debtor may be denied a discharge, or have the discharge revoked, for failing to cooperate with the trustee.26 Therefore, it is imperative for a debtor to cooperate with the trustee.


    Bankruptcy is a unique area with its own language, and with procedures not found elsewhere in the law. When representing consumer debtors in a Chapter 7 bankruptcy, the attorney should do the following. With regard to schedule preparation: 1) do not rely on the debtor's memory; 2) press the debtor for information; 3) obtain documents; 4) perform necessary searches; and 5) because of the possible civil and criminal penalties, advise the debtor: disclose, disclose, disclose. The attorney also should assist the debtor in cooperating with the trustee. Finally, because there is no substitute for experience, the attorney should discuss any questions with experienced bankruptcy practitioners before the case is filed.


    1Bankruptcy Court for the Western District of Wisconsin, Bankruptcy Statistics Total Bankruptcy Filings by Year 1968-2001.

    2Eastern District of Wisconsin, Chapter 7 filings, 1992-2001.

    3News Release, Administrative Office of the U.S. Courts, Feb. 25, 2004.

    4See 11 U.S.C. § 727.

    5See 11 U.S.C. § 523.

    611 U.S.C. § 727.

    7Federal Rules of Bankruptcy Procedure (FRBP) 4004(a).

    8352 F. 3d 1125 (7th Cir. 2003), cert. denied, 124 S. Ct. 2176 (2004).

    9FRBP 1007(c).

    1011 U.S.C. §§ 523, 727, 18 U.S.C. §§ 151-157.

    11FRBP 1007(b).

    12For example, forms for bankruptcy schedules A-J are available at www.uscourts.gov/bkforms, www.wiw.uscourts.gov/bankruptcy, and www.wieb.uscourts.gov.

    13FRBP 4003(b).

    14FRBP 1009.

    1511 U.S.C. § 362.

    1611 U.S.C. § 541.

    1711 U.S.C. § 522(b).

    1811 U.S.C. § 554.

    19The U.S. Trustee's office, a component of the U.S. Department of Justice, is responsible for overseeing the administration of bankruptcy cases and private trustees.

    2011 U.S.C. § 702. (As an aside, in the thousands of cases in which the author has been involved, he has never seen an election of a trustee.)

    2111 U.S.C. § 548.

    2211 U.S.C. § 101(31).

    2311 U.S.C. § 506.

    2411 U.S.C. § 727(a).

    2511 U.S.C. § 521(3).

    2611 U.S.C. § 727(a), (d).

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