For some filing for bankruptcy will not only bring a lot of much needed relief it is actually a smart financial step. Bankruptcy can clear away a lot of debt and truly provide a fresh start. However there are situations where filing for bankruptcy can be a very bad idea. In this article I will discuss four scenarios where bankruptcy could end up being more trouble than it is worth.
#1 – You Have Unprotected Assets
This applies specifically to a chapter 7 bankruptcy. A chapter 7 filing is a relatively short process and really packs a punch in that it will eliminate almost all of your unsecured debts. Debts like medical bills, credit cards, personal loans, etc. will be completely eliminated.
However, chapter 7 is a liquidating bankruptcy, meaning if you have assets that are not protected by one of your state’s exemption laws there is a chance the bankruptcy trustee will seize the asset, sell it, and give the money to your creditors.
With this in mind if you have significant non-exempt assets a chapter 7 filing could end up costing you a lot in terms of lost assets. For instance, if you live in Arizona and you own a boat free and clear of any loan then there is a good chance it would be seized. Same thing for ATVs, RVs, and most other big-ticket toys.
Exemption laws protect most of your essentials likes household items, a car, wedding rings, retirement accounts, etc. But if you happen to have something valuable that is not protected you may want to reconsider your decision to file a chapter 7 bankruptcy and possibly look to a chapter 13 bankruptcy where you won’t lose the assets (but will be required to complete a payment plan over 5 years).
#2- You Recently Gave Away Assets
If you are considering filing for bankruptcy it is best to maintain the status quo. And what I mean by that is you shouldn’t be taking your name off the title on vehicles or transferring assets to another family member. This can cause big problems.
In bankruptcy there are laws that state if you have given away an asset to someone who didn’t pay you anything within two years prior to your bankruptcy filing then it is considered a “fraudulent transfer” whether you actually had any fraudulent intent or not.
The reason these laws are in place is because they don’t want people to transfer all of their assets out of their name, file bankruptcy, and then transfer everything back into their name once the bankruptcy is complete. This would be unfair to your creditors. So the law allows the court to undo those transfers that occurred within two years prior to your bankruptcy filing in which you gave away an asset and didn’t receive anything (or its equivalent value) in return.
The most common scenario where I see this occur is almost always very innocent. A couple needs to file for bankruptcy and prior to filing they transfer the title to a vehicle that their twenty-something kid has been driving since they were 16 years old. Even though there is no intent to defraud your creditors the kid ends up getting a call from the bankruptcy trustee to turn the vehicle over. If you are in a similar situation it is best to meet with a bankruptcy lawyer before you transfer your name off of any asset. It could end up saving you and the person you transferred the asset to a lot of grief and money.
#3- You Recently Paid Back a Lot of Money to a Family Member or Friend
I understand why people do this, but it can cause problems in your bankruptcy filing. The thinking goes along these lines – I am going to file for bankruptcy, I owe my brother $5,000 and I don’t want him to think that I am not going to pay him back, so I am going to pay him back and then file my bankruptcy.
The reason why this can be a problem is that one of the big ideas underlying the bankruptcy system is that your creditors will be treated equally and any distribution of money will result in all of your creditors getting their fair share of the money.
If you pay your brother $5,000 and pay your credit cards $0 then you are clearly “preferring” your brother over your other creditors and this is know as a “preference”. How the rule works is if you have paid any of your run of the mill creditors more than $600 in the 90 days prior to your bankruptcy filing the bankruptcy trustee can go and ask for that money back. Further, if you have paid any of your family members or close friends back in the last 12 months then the bankruptcy trustee can go and demand that they give the money to the court so that it can be distributed fairly to all of your creditors.
Having a bankruptcy trustee contact your brother can not only make Thanksgiving really awkward but may be a reason to not file a chapter 7 bankruptcy – or at least to consider postponing it until a year has passed since you paid the debt.
#4 – You Have Debts that You Incurred Through Fraud
This one is rare, but if you have debts where there was fraud involved filing bankruptcy may not be a good idea. Here’s why…if a creditor believes that a debt you owe was incurred fraudulently they have the right to come into your bankruptcy case and file a mini-lawsuit known as an adversarial proceeding to ask the court to determine if their debt was incurred through your fraud.
If the judge determines it was, then that specific debt will be deemed non-dischargeable, meaning that this particular debt is yours to keep for life. It will not be going away in the bankruptcy. Adversary proceedings cannot only result in a debt not being discharged in your bankruptcy but can be costly as the legal fees for defending an adversary proceeding are usually not included in the flat rate bankruptcy fee.
It is important to note that these types of proceedings are pretty rare and the requirements to prove fraud is not easy to do. Incurring debts and then running into hard times and not paying back your debts is not fraud. However if you are involved in a Bernie Madoff- type scheme, bankruptcy likely won’t be a good option.
If I Can’t File Bankruptcy What are My Options?
I understand that it is all fine and good to understand that there are situations where a bankruptcy filing could cause you a lot of grief, but that doesn’t help you deal with your debt problem.
There are other options, including bankruptcy options that can help you to eliminate most, if not all, of your debts. Most of the problem-scenarios described above really are only problems in a chapter 7 filing (with the exception of fraud – that will be an issue in any type of bankruptcy).
Chapter 13 bankruptcy can be a viable option that will allow you to keep your assets and eliminate most of your unsecured debts. You will have to make a payment to your creditors over the next 5 years, but in the end you will likely be able to eliminate most of your debts.
Another option is debt settlement. Debt settlement is the process where you approach your creditors and offer to pay them an amount less than what is actually owed. Debt settlement can work but has the obvious downside that you will need to have a fair amount of cash to make it work.
One of the most important take-aways I can give you in this article is if you are considering bankruptcy meet with a bankruptcy attorney early on in the decision making process. Too often people meet with an attorney after decisions have been made that will adversely impact the bankruptcy filing. Almost all bankruptcy attorneys will meet with you at least once for free and can give you a pretty good idea of things you should and shouldn’t do in leading up to your bankruptcy filing.
Looking for More Information on the Bankruptcy Process?
What I have provided you here in this article is just the beginning when it comes to gathering information on the bankruptcy process. I have put together an video course that will review the entire bankruptcy process for both chapter 7 and chapter 13 bankruptcy and can provide you with valuable information as you consider whether or not bankruptcy is your best option.
Click HERE or the course “Bankruptcy Basics – Understanding the Pros and Cons of Filing for Bankruptcy“
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John Skiba, Esq.
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