Earlier this week, the U.S. Supreme Court heard arguments in a case that could affect many Americans who seek financial relief from Chapter 7 bankruptcy. Here’s a look at what’s going on.

Background: Chapter 7 Bankruptcy

Chapter 7 bankruptcy (sometimes called liquidation), works by giving debtors a complete discharge of many non-secured debts. Though the debts are forgiven, some filers must sell off some of their property to raise money to pay whatever they can against the debts.

Filers are also entitled to keep specific items of property; these exemptions are determined by state law.

The Case: A Caterer’s Equipment

In the case before the Court…

• A caterer filed for Chapter 7 bankruptcy. When she filed in 2005, she indicated on her forms that the equipment required to run her catering business was worth $10,718 – exactly the value of property her state permitted in exemptions.
• An auctioneer valued her equipment. He estimated that her gear was worth closer to $17,000, which would mean she’d have to auction some of it off to repay her creditors.
• Her trustee never filed an objection. William Schwab, the bankruptcy trustee assigned to the case, failed to file an objection before the deadline. Though he reportedly filed a motion in court to have the caterer sell her equipment to raise $10,718, she countered that, because of the missed deadline, this request was unfounded.

So far, the bankruptcy court and the appellate courts have sided with the caterer here, essentially ruling that, because the trustee did not file his motion in time, it cannot stand.

Possible Implications

It seems the Supreme Court justices have expressed two major concerns:

• Trustees have insufficient time to review all their cases. This could lead to more oversights like the one in the caterer’s case and could promote bankruptcy fraud among unscrupulous filers.
• Filers have motivation to undervalue their possessions. Naturally, if there’s a chance your trustee isn’t reviewing your case that carefully, that provides an incentive to underestimate the value of your possessions so you have a chance of keeping more stuff.

Take-Home Lesson

Reports indicate that the caterer who filed for bankruptcy clearly filled out her forms and indicated that she had no exempt property, which suggests that the error of careless oversight may indeed be her trustee’s. If you are filing for Chapter 7 bankruptcy, you may want to speak with a bankruptcy lawyer who can help make sure you take necessary steps to protect yourself and your property when you file.

Additional Resources

Summary of Significant Changes Implemented by BAPCPA in 2005 (PDF)