I recently received an email that posed an interesting scenario in Chapter 7 bankruptcy liquidation.  Although I have written on the subject of Chapter 7 liquidation I haven’t addressed the specific fact pattern in detail.  This post fills that lacuna.

The question posed was a bit long, so I will summarize it.  The questioner asked whether a sufficiently large tax lien on a debtor’s principal residence would dissuade a Chapter 7 Trustee from seizing and liquidating the house.  My answer not only deals with the question posed, it also includes a discussion of the exemption implications as well.

The analysis depends primarily on 724(a), 726(a)(4), and 11 U.S.C. §§ 551.  Based on these Code sections, the tax lien has two potentially negative implications to the case.

I.  The Trustee Can Avoid The Tax Lien To Create Equity For The Estate

A.  The Taxing Authority Will Release The Lien

If there appears to be no realizable equity solely because of a tax lien, the Trustee is free to ask the taxing authority ― whether the IRS, or the FTB, or both ― to release the lien to create realizable equity for the bankruptcy estate.  A taxing authority is willing to release a lien in this context because upon liquidation of the asset, its priority tax claim will be paid ahead of the general unsecured debt ― meaning that the taxing authority will get money right away rather than having to wait for the debtor to sell or refinance the property.  In addition, after the Court grants the debtor a discharge, the taxing authority will still have a claim against the debtor for the unpaid, nondischargeable portion of the tax debt.  Thus, from the taxing authority’s perspective, there is no down side to releasing the lien.
Continue Reading Liquidation Of An Asset In A Chapter 7 Bankruptcy II

I am regularly asked what happens when a Chapter 7 Trustee sells a debtor’s asset in a bankruptcy.  This post answers that question.

I.      Business Chapter 7

If a business files for Chapter 7 bankruptcy protection, the Chapter 7 Trustee assigned to the case seizes all of the business’s assets and liquidates them.  As part of the liquidation the Trustee pays off all encumbrances against the assets — e.g., mortgages against real property — pays the cost of selling the assets, takes the statutory cut found in 11 U.S.C. § 326(a), and distributes the remaining proceeds to the creditors according to the priority rules found in 11 U.S.C. §§ 507(a) and 726(a).

When the smoke all clears the debtor ceases to exist, which is why a business is ineligible for a Chapter 7 discharge pursuant to 11 U.S.C. § 727(a)(1).

II.     Personal Chapter 7

I am pleased to report that although the title of Chapter 7 in the Bankruptcy Code is “Liquidation,” no individual debtors are liquidated in a Chapter 7 bankruptcy.  However, there can be a liquidation component to the case.

A.  Exempting Assets

I have already written about exempting assets many times — see, e.g., the September 16, 2011 post.  Therefore, I won’t discuss that topic here; other than to say that in a personal Chapter 7 bankruptcy the debtor keeps the exempt assets, while the Chapter 7 Trustee seizes and liquidates the nonexempt assets for the benefit of creditors.

B.  The Liquidation

When faced with a nonexempt asset, a Trustee must answer a question:  Is it worth the time, effort, and expense to do the liquidation?  Here is the analysis the Trustee will do:

1.  How much is the asset worth?

Although the debtor provides an estimated value in the bankruptcy papers, this estimate does not bind the Trustee — even if the estimate was a professional appraisal of the property.  The only way to really determine the value of the asset is to put it on the market because an asset is only worth what the market will pay for it.  Of course, a professional appraisal may dissuade the Trustee from taking further action because the appraisal may indicate the futility of selling the asset due to the required payout discussed below.
Continue Reading Liquidation Of An Asset In A Chapter 7 Bankruptcy