Bankruptcy is a legal way to start all over again financially, but it’s getting less and less popular in America.
There were 819,760 consumer bankruptcy filings in 2015, according to the American Bankruptcy Institute, more than 90,000 fewer than in 2014. In fact, that makes the fifth straight year the number has dropped since 1.5 million people filed in 2010.
Still, that’s almost a million people ready to cash out on everything they own (a.k.a Chapter 7 bankruptcy) or try to buy some time to protect what they have while they figure out how to pay their debts (a.k.a Chapter 13 bankruptcy).
Chapter 7 bankruptcy cases take 4-6 months to settle and Chapter 13 filings can last a year or more. The secret to success with either one is almost always predicated on the time spent planning ahead of the actual filing.
“It all depends on how you treat the pre-bankruptcy planning,” David Leibowitz, a bankruptcy attorney in Chicago and founder of the Lakelaw firm, said. “Good pre-bankruptcy planning is great. Bad bankruptcy planning can result in losing your discharge and maybe even going to jail.
“You can either do some smart things that will really help your case or you can do things that will get you in serious trouble.”
What Is Pre-Bankruptcy Credit Counseling?
The 2005 Bankruptcy Abuse Prevention and Consumer Protection Act made it a requirement that anyone filing for bankruptcy must take a credit counseling session at least 180 days before filing.
Pre-bankruptcy credit counseling is an opportunity to receive advice from an approved counselor on whether there is some other way for you to get back on your feet financially, or is bankruptcy really the only choice.
You are not required to accept any suggestions or proposals made by credit counselors, but you are required to participate in what usually is a 40-60 minute session. The counseling can be done in person, over the phone or is available online.
The counseling must come from a nonprofit budget and credit counseling agency that was approved by the U.S. Trustee program. The agency issues you a Certificate of Credit Counseling as proof that you took the course and you must present the certificate when filing for bankruptcy.
Anyone filing for bankruptcy must take the credit course, regardless of what chapter of bankruptcy you file for. If you don’t have a certificate, your case may be dismissed.
A separate counseling session, called “Debtor Education” or “Post-Discharge Counseling” is required after you have filed your petition for bankruptcy. This is entirely different than the pre-bankruptcy credit counseling. It focuses on financial management, how to budget and other things you need to know to manage your debt successfully.
The two courses can’t be taken at the same time.
Think First Before Declaring Bankruptcy
The first step any consumer should take when considering bankruptcy is to determine whether you even qualify for it. Some financial problems are better handled through debt management programs, debt settlement or even a consolidation loan.
Bankruptcy is the “nuclear option” when you have exhausted all other avenues for resolving your debt problems.
You should also understand that bankruptcy is a legal status. A judge rules on it, deciding whether the evidence you present means you are unable to pay the debts you accumulated.
In other words, you don’t declare bankruptcy and hope all your creditors (and bills) go away. You file for it, make your case in front of a judge and hope the judge grants you a fresh start.
That means examining your assets and measuring them against your expenses and seeing if there isn’t some way to balance the two without declaring bankruptcy.
Are Your Assets Exempt or Non-Exempt?
Assets include things like cash in savings or checking account; proceeds from sale of a second home or automobile; valuables like art, jewelry, coin or stamp collection – basically anything you can sell that will bring in money to pay off your debts.
Expenses are all of your bills, anything you owe money on.
Some of your property is exempt from bankruptcy, meaning creditors can’t force you to sell it. You can retain exempt property, as long as you can identify it and show it’s reasonable and necessary to how you live and work.
For example, you won’t have to cash in retirement savings or sell your home or the necessary furnishings in it. You can keep the car you use to go to work, the clothes you need for work and the tools that you use in business, whether it be computers or a hammer or a chainsaw.
Make sure to list all the things you hope would be considered “exempt” and ask a lawyer or research online to find out whether those things qualify in that category.
“The goal of pre-bankruptcy planning is to protect as many of your assets as the law allows,” said David Krekeler, founding principal of the Krekeler Strother law firm in Madison, Wisconsin. “To do that, you need to consult with someone who knows what they’re talking about. Bankruptcy is a very detailed process. There is a lot of opportunity to miss things and make mistakes.”
Important Factors to Consider Before Filing Bankruptcy
The pre-filing bankruptcy process includes decision making on an attorney, the type of bankruptcy you intend to file, the timing for filing and gathering proof of your debts Here are things to think about before making a decision.
- Do I need an attorney or not? There were 49,344 pro se bankruptcy cases filed in 2015, meaning 49,344 people represented themselves. Another 25,639 people filed pro se for Chapter 13 that year and according to the Consumer Bankruptcy Fee Study, zero ended successfully, meaning the debtor received a discharge. In other words, be careful about doing this yourself. Odds are not with you.
- Do you want to file Chapter 7 or Chapter 13? Chapter 7 means liquidating all your non-exempt property, handing the money over to creditors and walking away from all unsecured debts and medical bills. It’s the easiest, most-often used form of bankruptcy, but there are severe consequences for Chapter 7. It remains on your credit report for 10 years and definitely affects whether you ever own a home or even a car again. Chapter 13 is for individuals who believe that, given time and some concessions, they can pay their debts. Courts normally allow you to present a plan that would either resolve or catch up all debts within 36-60 months and not lose or sell your property. Chapter 13 bankruptcy appears on your credit report for seven years.
- Consider the timing of your bankruptcy. A successful bankruptcy case discharges only the debts that exist on the day you file. If you expect to have continuing medical costs, for example, you might want to wait until all costs are in. Similarly, if you just had a windfall of money like a tax return or inheritance, it might be best to wait before filing.
- Take a “Means” Test. The 2005 Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 requires you to take a “means” test. You calculate your income for the last six calendar months and see how it compares to the median income for your state. If it’s below the state average, you qualify to file Chapter 7. If it’s above, Chapter 7 is out, but you can still file Chapter 13. You also could qualify if your disposable income – the amount left after subtracting reasonable monthly expenses from monthly income – does not meet certain standards.
- Start gathering proof. Bankruptcy is a legal proceeding so any claims you make about expenses or income must be backed up with paperwork. Typically, this takes a considerable amount of time so if you’re even lightly considering filing, you should start putting together everything that proves you need the protection bankruptcy provides.
Pre-Bankruptcy Planning Tips
Given the restrictions on how much of your property is considered exempt (protected) and non-exempt (unprotected), it makes sense to preserve those assets well in advance of filing for bankruptcy by consulting an expert in bankruptcy law.
Generally speaking, you are best served by liquidating non-exempt assets and using whatever cash you have available to pay down exempt assets. This is legal as long as the money is used for reasonable living expenses like mortgage, food, transportation or utilities.
For example, if you own stocks that are not part of your exempt retirement plan, you could sell the stocks and apply the money to your mortgage.
You might also own an expensive car that has significant equity and could be sold for a significant sum. That’s OK, as long as the money is used to purchase a less expensive car and what’s left over is applied to other living expenses.
You might consider moving your savings and checking accounts to a different bank. When you have a savings or checking account in the same bank as your car loan or credit card, the bank can use the money in your account to pay down the balance owed on the date you filed bankruptcy.
Another example involving banks is when you have authorized automatic payments from your account. It would be wise to stop those payments before filing so the money can be used for living expenses.
There is a very fine line in doing this and it is important that you understand not to cross it. Fraud, theft and lies are not tolerated well in bankruptcy proceedings. Creditors can ask a judge not to discharge a debt – or even all the debts – if the creditor believes there was abuse involved with it.
The bankruptcy trustee could ask that no debts be discharged if they believe there was considerable abuse in attempt to conceal assets. It’s even possible that the debtor could face criminal liability.
“Bankruptcy is intended for the unfortunate, but honest debtor and not someone who is going to engage in culpability for bad acts,” Krekeler said. “An experienced professional can answer questions, probably off the top of his or her head, and tell you what you need to do and the right way to go about it.”
Things You Should Not Do before Filing for Bankruptcy
In case you’re wondering if you crossed the line when trying to protect assets before filing for bankruptcy, here are a few examples … or warnings!
The first is choosing who to repay and who not to repay. If you intend to use money or property to settle some debts before filing for bankruptcy, you should treat all creditors equally. If you show a clear preference in who you paid before filing, the bankruptcy trustee could come back later and take back all or part of the money.
For example, paying your brother back for a personal loan he made to you, but refusing to make an installment payment on a car or credit card payment is considered wrong. This is known as an “avoidable preference” and may end up being nullified by a bankruptcy trustee.
The same is true for people who try to “give” their assets to friends or relatives before filing for bankruptcy. It is fraud to give the keys to your paid off car to your nephew or a gold, diamond ring to your daughter or give your best friend a 50% discount on a lake house.
Credit cards can be a major problem in pre-bankruptcy filings. People who know that their credit card debt will be discharged when they file, might try to take advantage of it by using the card to fund a vacation or expensive purchase or go on a clothes shopping spree before filing.
Bad move! Judges regard that as defrauding the system.
The easiest way to avoid this is to give away property or repay debts to relatives or friends at least one year before filing for bankruptcy. Another option is to transfer your assets while you’re still solvent. You are considered solvent when your assets exceed your liabilities.
“The most important thing about this is don’t try to hide assets, don’t try to transfer them to family, friends or some relative because nobody knows about them,” Leibowitz said. “This is something people do a lot of times and all they end up doing is getting themselves in trouble.”