(1) Ordinarily, secured creditors are paid out of their collateral.

(2) Unsecured priority claimants receive distribution ahead of the general unsecured creditors.

(3) If there is not enough money to pay all claims at a particular level, claimants within that level take a pro rata share.

(4) Liens for certain kinds of penalties can be avoided by the trustee, and tax liens are subject to subordination.

(5) Special rules apply to partnership debtors when there are insufficient assets to pay all the claims against the partnership. Questions arise as to whether the debtor should receive a discharge under Chapter 7. Look for any of the ten grounds for denial of a discharge (e.g., the debtor is not an individual, or she transferred property with the intent to hinder, delay, or defraud a creditor). If the facts do not show any of the grounds for denial, a discharge must be granted, although under appropriate circumstances, a discharge may be revoked. Finally keep in mind that the debtor may convert a Chapter 7 case to Chapter 11, 12, or 13 if the case has not been converted earlier and the debtor is eligible under the other chapter. Also, the court may dismiss a case for cause or if a consumer debtor has substantially abused Chapter 7 relief.

A. INTRODUCTION

Eligibility for Relief:  A person (individual, partnership, or corporation) that resides or has a domicile, a place of business, or property in the United States may be a debtor under Chapter 7, unless specifically excepted. (B.C. § 109(a), (b))

a. Exceptions: The following persons are not eligible to be debtors under Chapter 7 [B.C. §109(b)]:

(1) Railroads [B.C. §109(b)(l)];

(2) Domestic banks, insurance companies, credit unions, savings and loan associations, building and loan associations, homestead associations, cooperative banks, and other similar institutions [B.C. §109(b)(2)];

(3) Foreign banks, insurance companies, and other similar financial institutions, that are engaged in business in the United States [B.C. § 109(b)(3)]; and

(4) An individual or a family farmer who was a debtor in a case that was dismissed in the preceding 180 days because of the debtor's intentional failure to obey court orders or to appear before the court, or because of the debtor's request for a voluntary dismissal of the case following a party's request for relief from the automatic stay [B.C. §109(g)].

Chapter 7 Trustee: Immediately after the order for relief, the United States trustee appoints a disinterested member of the panel of private trustees to serve as the interim trustee in a Chapter 7 case. [B.C. §70l(a)(l)] Then, either a trustee is elected at the section 341 meeting of creditors or the interim trustee automatically becomes the permanent trustee in the case. [B.C. §702]

a. Duties of trustee: In a Chapter 7 case, the trustee's primary responsibilities are to locate and collect property of the estate; to convert the property to cash; to make distributions to claimants in the order established by the Bankruptcy Code; and to close the estate expeditiously. [B.C. §704(1)]

2.Additional administrative duties of the Chapter 7 trustee are described in Bankruptcy Code section 704

3. Authority to Operate Debtor's Business: Occasionally, the trustee may receive authorization from the court to operate the debtor's business temporarily, under circumstances where continuing the business for a while is in the best interest of the estate and will assist in its orderly liquidation. Such a situation may arise where an attempt  is being made to sell the debtor's business as a going concern or where completing the manufacture of unfinished commodities is likely to result in a substantially greater liquidation price. [B.C. §721; 4 Collier 1(721.02]

4. Meeting of Creditors: Within twenty to forty days after the order for relief, the United States trustee convenes and presides at the section 341 meeting, where creditors often participate in many of the following matters [B.C. §341(a)]

 a. Examination of the debtor, under oath, by creditors, the trustee or an examiner in the case, or the United States trustee [B.C. §343];

b. The election of a trustee, when requested by a sufficient number of unsecured creditors [B.C. §702]

c. Election of a creditors' committee, when desired, consisting of between three and eleven unsecured creditors, to act in an advisory role in consultation with the trustee. Discussion about the trustee's abandonment of properly that is burdensome or of inconsequential value to the estate [B.C. §554] Discussion about an individual debtor's redemption of tangible personal property intended primarily for consumer use [B.C. §722] and, Discussion about the debtor's reaffirmation of particular debts [B.C. §524(c)]

 H. DISTRIBUTION OF PROPERTY OF ESTATE

1. Order of Payment: Claimants in a Chapter 7 case receive distribution according to the order prescribed by Bankruptcy Code sections 725 and 726.

a. Secured creditors: Claims that have been allowed as secured are paid first. They are paid from the collateral securing their claims. [B.C. §725] Remember that in bankruptcy a claim is deemed secured only to the extent of the value of the creditor's collateral. [B.C. §506(a)]

Over secured creditors: Recall that, to the extent that the value of a secured parties collateral exceeds his allowed secured claim, any post-petition interest, and any fees, costs, or charges that are allowed generally accrue until the time of distribution in a Chapter 7 case. [B.C. §506(h)]

b. Priority claims: Next, unsecured claims entitled to priority under section 507 are paid in the following order [B.C. §726(a)(l)]:

(1) Administrative expenses [B.C. §507(a)( 1 )];

(2) Involuntary case gap claims [B.C. §507(a)(2)];

(3) Wages, salaries, or commissions [B.C. §507(a)(3)];

(4) Contributions to employee benefit plans [B.C. §507(a)(4)];

(5) Claims of grain farmers and United States fishermen [B.C. §507(a)(5)];

(6) Consumer lay away claims [B.C. §507(a)(6)[;

(7) Unsecured pro-petition taxes [B.C. §507(a)(7)]; and

(8) Capital requirements of an insured depository institution [B.C. §507(a)(8)].

c. General unsecured claims: After the priority claims have been satisfied, the general unsecured claims that have been filed timely and have been allowed are paid. [B.C. §726]

Justifiably tardy claims: Also included in this category are claims that have been filed late due to the creditor's lack of notice or actual knowledge of the case—as long as the claims were filed in time for distribution. [B.C. §726(a)(2)(C); In re Columbia Ribbon & Carbon Manufacturing Co., 13 Bankr. Ct. Dec. 962 (Bankr. S.D.N.Y. 1985)]

d. Unexcused tardy claims: Unsecured claims that were filed late, without legal justification (see above), are paid after the other general unsecured claims. [B.C. §726(a)(3)]

e. Penalty claims: Next in the order of distribution are unsecured or secured claims for punitive, exemplary, or multiple damages, or for lines, penalties, or forfeitures that do not constitute compensation for actual pecuniary loss. [B.C. §726(a)(4)]

f. Interest: If the estate is solvent, after all of the claims above have been satisfied, post-petition interest at the legal rate is paid on claims under section 726(a)(l)-(4) from the date that the bankruptcy petition was filed. [B.C. §726(a)(5)]

g. Payment to debtor: If there is any properly of the estate left after payment of post-petition interest on the unsecured claims, it is distributed to the debtor. [B.C. §726(a)(6)]

Pro Rata Payment: Claims within any type of priority under section 507(a), or within any level of distribution under section 726(a), share pro rata in the properly distributed to that particular category of claims.

 a. Example: Debtor Corporation files a voluntary Chapter 7 petition. There are no secured creditors, and the general unsecured claims total $30,000. Administrative expenses arc $5,000, and each of ten employees of Debtor Corporation holds a third priority wage claim in the amount of $1,000. Unsecured pre-petition tax claims, with seventh priority status, total $20,000. If the amount available for distribution is $10,000, the administrative expenses will be paid in full ($5,000), and the ten employees will receive $500 each. The holders of the priority tax claims and the general unsecured claims will receive nothing. [B.C. §726(b)]

b. Exception—converted case: |In a case that has been converted to Chapter 7 from Chapter 11, 12, or 13, the administrative expenses allowed in the Chapter 7 case after conversion have priority over any administrative expenses incurred prior to conversion. [B.C. §726(b)]

3. Community Property: If any properly of the estate constitutes community property [B.C. §54l(a)(2)], it must be segregated from other properly of the estate. Special rules for distribution apply, including the payment of administrative expenses, either from the community property or from the other properly ot me estate, as justice requires.

4. Exception-Subordination of Claims:  While the claims in a Chapter 7 case ordinarily are paid in the order described above, some claims could be subordinated to a lower rank in the distribution, such as when there is a subordination agreement, there are claims of defrauded security holders, or the principles of equitable subordination apply. [B.C. §§726(a)]

C. TREATMENT OF CERTAIN LIENS IN CHAPTER 7 CASE

1. Avoidance of Liens Securing Penalties: The trustee may avoid a lien securing the type of claim described in Bankruptcy Code section 726(4) for a fine, penalty, or forfeiture, or for punitive, multiple, or exemplary damages that do not constitute compensation for actual pecuniary loss. [B.C. §72l(a)] note: The priority claimants entitled to distribution under section 724(b)(2) do not include seventh priority unsecured tax claims [B.C. §507(a)(7)]

(iii)  to the extent that the allowed secured tax claim is greater than the total of all distributions made under section 724(b)(2) to priority claimants [B.C. §724(b)(3)];

(iv) To any lien holder possessing an allowed claim secured by a non-avoidable lien on the collateral that is junior to the tax lien [B.C. §724(b)(4)];

(v) To the tax lien holder to the extent that the allowed secured tax claim is not satisfied under section 724(b)(3) [B.C. §724(b)(5)]; and

 (vi) To the Chapter 7 estate [B.C. §724(b)(6)]. [B.C. §724(b)]

. Example: Debtor Corporation files a voluntary Chapter 7 petition, and the only property available for distribution is a building that is worth $20,000. The Internal Revenue Service holds an allowed claim for $7,000, secured by a perfected tax lien on the building. Bank A holds a $10,000 claim secured by a non-avoidable lien on the building that is senior to the tax lien. Bank B holds a $2,000 claim secured by a non-avoidable lien on the building that is junior to the tax lien. Administrative expenses in the case total $4,000, and there also are priority claims in the amount of $1,000 for pre-petition wages owed to employees of Debtor Corporation. If the building is sold for a price of $20,000, distribution in the case will be as follows: (i) to Bank A in the amount of $10,000; (ii) to the priority claimants for the expenses of administration ($4,000) and for the employees' wages ($1,000); (iii) to the IRS in the amount of $2,000, which is the extent that its allowed secured tax claim ($7,000) exceeds the total payments to the priority claimants ($5,000); (iv) to Bank B in the amount of $2,000; and (v) to the IRS in the amount of $ 1,000, which arc the only funds remaining. Thus, as a result of the subordination of its lax lien in the Chapter 7 case, the IRS receives a total distribution of only $3,000 on its allowed secured claim. [B.C. §724(h)]

Multiple Claimants: Payment to more than one claimant within any particular level of distribution under section 724(b) (above) is made in the order that would have been required under the Code outside of the provisions for the treatment of lax liens. [B.C. §724(c)]

4. Similar Statutory Liens: Any statutory lien whose priority is determined by the same method as that prescribed under 26 U.S.C. section 6323 for the priority of a tax lien is treated, under Bankruptcy Code exactly like a tax lien, and is subordinated accordingly. [B.C. §724(d)]

 PARTNERSHIP TRUSTEE'S CLAIM AGAINST GENERAL PARTNERS

1. Deficiency of Partnership Property: Where the estate of a Chapter 7 partnership debtor lacks sufficient property to fully satisfy all claims against the partnership, the trustee is entitled to a claim for the entire deficiency against each general partner who is personally liable. [B.C. §723(a)]

a. Non-debtor general partners: In attempting to recover the deficiency, the trustee, where practicable, must first pursue any general partner who is not a debtor in a bankruptcy case. Under these circumstances, the court may require the partner to supply indemnity or other assurance of payment, or may enjoin the partner from disposing of property, until the amount of the deficiency is determined. [B.C. §723(b)]

b. General partners who are debtors:  The trustee's claim against the estate of each general partner who is it debtor in a bankruptcy case equals the total of all allowed creditors claims in the partnership's bankruptcy case. The trustee receives distribution on property with the general partner's individual unsecured creditor.

Disallowance of claims of partnership creditors: A creditor's claim for which both the partnership debtor and a general partner are responsible will be disallowed in the bankruptcy case of the general partner, except to the extent that the claim is secured solely by the general partner's property and not by the partnership's assets. [B.C. §723(c)]

2. Excess Recovery by Trustee: If the trustee in the partnership's bankruptcy case recovers from the debtor general partners an amount that exceeds a deficiency remaining after payment by the non-debtor general partners, the surplus will be returned to the debtor general partners' estates in an equitable manner. [B.C. §723(d)]

E. CHAPTER 7 DISCHARGE

1. In General: An individual Chapter 7 debtor must be granted a discharge, unless one of the ten independent statutory grounds for denial of a Chapter 7 discharge applies.[ B.C. §727(a)] The effect of the discharge is to discharge the debtor from all debts that arose prior to the order for relief under Chapter 7, as well as from all debts that, under Bankruptcy Code section 502, are treated as pre-petition debts.

a. Exception; non-dischargeable debts: The discharge does not include particular debts that the court has determined to be non-dischargeable under section 523. It is important to distinguish between a denial of the entire discharge under section 727, and a determination under section 523 that a specific debt is non-dischargeable. A denial of the entire discharge allows all creditors to pursue their claims post-bankruptcy; whereas if a discharge is granted, only those creditors who are owed debts found to be non-dischargeable under section 523 will be free to collect their claims post-bankruptcy.

2. Objection to Discharge: An objection to the debtor's discharge may be filed by a creditor, by the trustee in the case, or by the United Slates trustee. Also, when a party in interest requests, the court may order the trustee to investigate the debtor's conduct to determine whether there is a basis for denying the discharge. [B.C. §727(c)(l), (2)]

3. Grounds for Denial of Discharge: A Chapter 7 discharge may be denied for any of the reasons described below, in which case all of the debtor's debts will survive bankruptcy. [B.C. §727(a)(l)-(10)]

a. Debtor not an individual: Under Chapter 7, only an individual may receive a discharge. Therefore, other persons (e.g., corporations and partnerships) will not be granted a discharge, even though they may qualify to be debtors under Chapter 7 and may achieve an orderly liquidation of their estate while under the Bankruptcy Code's protection, including that provided by the automatic stay. [B.C. §727(a)(l)]

b. Transfer of property with intent to hinder, delay, or defraud creditors:  The debtor will be denied a discharge if she transferred, removed, concealed, mutilated, or destroyed property of the debtor, within one year before the petition was filed, or property of the estate, after the petition was filed, with the intent to hinder, delay, or defraud a creditor or an officer of the estate entitled to possession of the property. [B.C. §727(a)(2); In re Chastant, 873 F.2d 89 (5th Cir. 1989)] (1) Example: On May 1, Creditor obtains a judgment of $200,000 against Debtor, who is insolvent and whose only major asset is property known as Blackacre. On May 21, before Creditor has time to record the judgment as a lien against Blackacre, Debtor sells Blackacre to Friend for $110,000. The property is valued on Debtor's books at $250,000, and by Creditor's appraiser at $450,000. On May 22, Debtor executes a Chapter 7 petition, which she files on May 28. Creditor files a timely objection to Debtor's discharge. Since Debtor's transfer of Blackacre to Friend was made with the intent to hinder, delay, or defraud Creditor, and occurred within one year before bankruptcy, the court will deny Debtor a discharge under Chapter 7.

2. Involuntary Conversion:  Absent a request by the debtor, the court may not convert a Chapter 7 case to one under Chapter 12 or 13. |B.C. §706(c)] However, the court may convert a Chapter 7 case to one under Chapter 11, upon a request by a party in interest, after notice and a hearing. [B.C. §706(b)]

3.  Conversion of a Chapter 7 case to another chapter of the Code requires that the debtor be eligible for relief under the particular chapter to which the case is being convened. (B.C. §706(d))

DISMISSAL FOR CAUSE

After notice and a hearing, the court may dismiss a Chapter 7 case for cause [B.C. §707(a)], such as where: a. the debtor in guilty of an unreasonable delay that is prejudicial to creditors.

b. The debtor has not paid fees or charges prescribed by chapter 123 of title 28 [B.C. §707(a)(2)];

c. The debtor in a voluntary case has not filed a list of creditors and all schedules and statements required under section 521(1) within fifteen days (or any extension granted by the court) after the petition was filed [B.C. §707(a)(3)] (Note: A dismissal under section 707(a)(3) may be ordered only upon a motion filed by the United States trustee); or

d. Other appropriate cause warrants dismissal [B.C. §707(a)]

2. Substantial Abuse of Chapter 7: A case also may be dismissed, after notice and a hearing, if the bankruptcy petition was filed by an individual debtor with primarily consumer debts under circumstances constituting a substantial abuse of relief under Chapter 7. [B.C. §707(b)] In re Kelly, 841 F.2d 908 (9th Cir. 1988)] The motion to dismiss must be filed by the United States trustee or must be made sua sponte by the court; a dismissal under this provision cannot be initiated by a motion or suggestion of a party in interest. (B.C. §707(b)) but see In re Clark, 927 F.2d 793 (4th Cir. 1991)— motion can be filed by United States trustee even though initially suggested by a creditor.

a. Criteria:  The courts have considered the following factors in deciding whether to dismiss a Chapter 7 case on the ground of substantial abuse [B.C. §707(b)] In re Newsom, 69 Bankr. 801 (Bankr. D.N.D. 1987)]:

(1) The probability that the debtor's future expected income will be sufficient to pay a significant percentage of the unsecured claims under a Chapter 13 plan;

(2) The debtor's reason for filing the Chapter 7 petition, e.g., because of unemployment, medical expenses, disability, or other misfortune;

(3) The extent to which the debtor obtained cash advances and made consumer purchases beyond her ability to repay,

(4) The excessiveness or extravagance of the debtor's anticipated family budget; and

(5) The extent to which the debtor's income statement misrepresents her actual financial condition.

b. Presumption: There is a statutory presumption in the debtor's favor regarding the question of whether granting relief would be a substantial abuse of Chapter. [B.C. §707(b)]