Most people who file bankruptcy under Chapter 7 do not have to surrender anything to their trustee because everything they own is “exempt.”
Generally, Yes, You Can Keep Everything
Even though Chapter 7 is labeled the “liquidation” form of bankruptcy, most people who file under this simplest and most common form of bankruptcy keep everything they own. So most likely there would be no “liquidation”—you would not have to surrender anything to the bankruptcy trustee to have it sold and its proceeds paid to your creditors.
How Can You Keep Everything?
You get to keep everything you own as long as it all fits within the “property exemptions” that apply to you in your state. These are categories of assets that are protected, often up to a certain dollar. For most people, everything they own does fit within their exemption amounts.
Hundreds of years ago in the earliest English bankruptcy laws (which we inherited) there were no property exemptions. Whatever the “bankrupt” owned was gathered and sold to pay the creditors. But it became clear that taking absolutely everything from someone and leaving him or her destitute and a burden on society was good neither for society nor for the economy—besides being downright uncompassionate. So exemptions arose as a way to shelter a certain minimum amount of possessions so that the person could continue being a productive member of society in spite of needing to file bankruptcy.
Now we are fortunate that the exemptions are expansive enough so that most people needing bankruptcy relief can protect what they own.
State Exemptions in Federal Bankruptcies?
Which set of property exemptions you are allowed to use depends on the state in which you live. How can that be if bankruptcy, under the U.S. Constitution, is a federal procedure?
This goes back again to the history of exemptions. During the first hundred years and more of U.S. history, we actually did not have a permanent federal bankruptcy law. Instead a set of bankruptcy laws would be passed when there was a financial crisis—of which there were many during the 1800s—and then a few years later after the crisis had passed it would be repealed. In part that was because there was so much regional disagreement about exemptions, mostly between the Northeast where the big banks and other major creditors tended to be and the South and the West where the farmers and other debtors were more concentrated.
This long-running dispute about exemptions was also tied into the power struggle between states’ rights vs. the federal government, playing out in whether states or the federal government should decide what the property exemptions should be in bankruptcy.
So a creative grand compromise was struck: the federal Bankruptcy Code would have a set of federal exemptions, but each state could decide whether bankruptcies filed within that state could use those federal exemptions or instead had to use that state’s own set of exemptions.
So today, either you must use your state’s exemptions or else you have a choice between using those state exemptions or the ones in the Bankruptcy Code.
Will You Know Before Your Chapter 7 Case Is Filed Whether Everything is Exempt?
Pretty much, but not absolutely. Your attorney will work carefully with you to list categories of everything you own in your bankruptcy “schedules,” which you sign under penalty of perjury. He or she will tell you if it looks like everything is exempt, or whether there is any doubt about any particular item(s).
The value of certain possessions can be ambiguous, especially unusual things. So it may not be clear whether the applicable exemption dollar limit is sufficient to cover the item at issue. For example, a collection of certain kinds of memorability can be virtually worthless or it may have some meaningful value. Same with a partially restored but still-in-pieces classic car. Similarly, a home that needs a lot of serious repairs or is in the middle of major renovation may be hard to value.
Also, in some situations it may not be clear whether a particular asset legitimately fits within an exemption category, such as whether a houseboat or travel trailer that a person is living in qualifies for the homestead exemption.
But most of the time your attorney will be able to tell you with a fair amount of certainty that you either don’t have anything at risk, or if you do what your options are about protecting it.
**Please see our next blog post in a couple days about protecting your assets if they are not, or might not be, protected by an exemption.**