I use the term “bankruptcy estate” repeatedly – but what is a bankruptcy estate?
A legal fiction takes place when you file a bankruptcy. This fiction is that an estate is created at the time of filing, and this estate is distinct from the individual who is filing. This estate is administered by a Trustee, who is given the responsibility of maximizing profits for the creditors, while maintaining the fresh start of the Debtor, who gets to keep a certain amount of property. A trust is a separate legal entity. A Corporation is a good analogy – similarly, a corporation is a legal entity that exists separately from you.
Another way to think about it is that you lose control over your property for a limited period of time. (Less so in Chapter 11 and 13, but very much so in a Chapter 7) This is the price that Debtors pay for filing a bankruptcy.
Trustee’s make sure that the rules of bankruptcy procedure and the petitions are being prepared in a professional way but they are also incentivized by profit. This happens because they get to keep some of what they recover from a Debtor, in the event there is something to recover. Standing Chapter 7 Trustees are independent contractors, not employees of the government. They get paid a nominal sum (less than a hundred dollars) to speak with you at a hearing called a Meeting of Creditors. In a no asset case this is all they would receive. (By the way, this doesn’t mean there are no assets – it just means your assets are below a threshold amount that varies from state to state.)
In an asset case (meaning there are assets above the threshold amount) they are able to distribute the property to the creditors. If it is not a liquid asset, an auction is held where they solicit bids for a certain length of time. When it is sold, the trustee gets a percentage of the sale, and the rest is distributed to the creditors pro rata.
Chapter 7 is still the most preferred form of bankruptcy because most people don’t own that much, and don’t earn that much to be at risk. Because it only take a few weeks, and all your debts are discharged, it oftentimes seems like a straightforward and easy process. However, unlike Chapter 11 and Chapter 13, there is no turning back with a Chapter 7; once you have filed, you have put your assets in the hands of the bankruptcy estate. The risk may be low, but if you miscalculate, the consequences can be devastating.