Top 3 Mistakes People Make Before Filing Bankruptcy and How You Can Avoid Them

When the decision is finally made to file for bankruptcy usually it has been a long time coming.  Rare is the bankruptcy case that needs to be filed on an emergency basis.  For most there is sufficient time to gather all the needed documents and wrap up lose ends before taking the plunge and filing your case with the bankruptcy court.

Even with plenty of time to prepare for a bankruptcy filing there are certain things you must avoid in the months leading up to your case if you want everything to proceed smoothly.  Here are the top 3 mistakes I see people make in the lead up to bankruptcy.

#1 – Paying Off Loans to Family Members

This is understandable.  You are getting ready to drop a financial nuclear bomb and don’t want your family and friends to be harmed.  So you scrap together all the money you have and pay them back in preparation for the bankruptcy.

While this is understandable and may seem reasonable it can really throw a monkey wrench into your bankruptcy case.  The Bankruptcy Code prohibits transactions known as “preferences”.  A preference occurs when you “prefer” certain creditors over others.

The reasoning behind this law is sound.  The idea behind bankruptcy is that your creditors will all be treated the same (for the most part).  So if you take your money and pay off your brother for that money he loaned you and your creditors get none, well, the bankruptcy court thinks that isn’t fair to your other creditors.  So they can go back to your brother and kindly ask him to return the money so that it can be distributed evenly among all of the creditors.

And if your brother doesn’t give the money back then the bankruptcy trustee will sue him. If the person you paid back is a close friend or family member the bankruptcy trustee assigned to your case can look back an entire year before your case was filed to determine if there were any preferences.

#2 – Transferring Assets Out of Your Name

A big fear for many when filing for bankruptcy is that they are going to lose all their assets.  It is with this in mind that some believe it would be a good idea to get as many assets out of their name as possible prior to filing for bankruptcy.

This is not a good idea.

If you transfer your assets to someone else and don’t receive anything in return, and then file for bankruptcy, the bankruptcy trustee will once again be able to go to whomever you gave your assets to and get them back, sell them, and give the money to your creditors.

However, notice I said that a problem would arise if you transferred an asset and didn’t get anything in return.  You are permitted to sell assets prior to bankruptcy but you must get approximately what the asset is worth in return.

Best rule of thumb, keep everything status quo prior to filing bankruptcy.  Don’t take your name off anything, don’t transfer anything, unless you first run it by your bankruptcy lawyer.  Which leads me to the next mistake…

#3 – Not Keeping in Communication With Your Bankruptcy Lawyer

Sometimes the lead up to a bankruptcy filing takes several months.  Someone will come into my office, meet with me for a bankruptcy consultation, and then I won’t hear back from them for months when they are ready to move forward.  My advice here is once you have made the decision that you are going to file bankruptcy that you should retain a lawyer and keep in close communication with them before you make any significant changes in your assets, debts, or general financial situation.

Often things that don’t seem like a big deal to you are in fact huge deals when it comes to filing for bankruptcy (see #1 and #2 above).  If you are communicating effectively with your lawyer you can avoid a lot of the pot holes that people fall into once they get into the bankruptcy process.

With effective planning and guidance of an experienced bankruptcy lawyer filing bankruptcy isn’t anywhere near as bad as you might be thinking.

Photo Credit: Glyn Lowe