Bankruptcy is everywhere. Bankruptcy affects everyone including, but not limited to, Debtors, Creditors, Lending Institutions, Accountants, Financial Analysts, Mortgage Brokers, Real Estate Agents, All Types of Lawyers, Potential Homebuyers, Owners of Real Property, The President of the Bank of Mom & Dad, etc. Therefore, an understanding of the Bankruptcy Code and the principals enunciated therein are essential for everyone.
Bankruptcy law is extremely complex and, like other specialties, takes a significant investment of time to master. The purpose of this article is not to make you an expert in Bankruptcy law. This article is intended merely to apprise you of various misconceptions about Bankruptcy that arise every day. As with any area of the law, you should seek the advice of an experienced attorney before taking any action.
There are several misconceptions about Bankruptcy that everyone should be aware of. I will attempt to dismiss the most blatant misconceptions. Here is my Top 10 list of Common Bankruptcy Misconceptions.
1. The debtor (footnote 1) must be broke to file Bankruptcy.
Nothing can be further from the truth. With limited exceptions, the only requirement to file for Bankruptcy is that the Debtor cannot pay their bills as they come due (sometimes referred to as financial distress). This makes sense when given some thought. If a person had to be broke to file Bankruptcy, that person would not be able to pay their attorney, which would lead to a proliferation of pro se Debtors which would clog the Courts and drive the entire Bankruptcy Court system insane.
Next, if the "broke" Debtor cannot file Bankruptcy, they would in all likelihood become public charges since they have nothing left to live on. To avoid this burden on the government, Congress has permitted "exemptions" to allow Debtors to keep a certain amount of property despite the Bankruptcy filing. For example: in New York a person filing for Bankruptcy is permitted to have, among other things, up to $5,000 in cash, $4,000 worth of equity in an automobile as well as unlimited funds placed in a qualified 401K plan (footnote 2).
Finally, because individuals and businesses normally wait till they are broke to seek Bankruptcy advice, this unnecessary delay precludes options available to them which may help them reorganize their finances and permit them to keep part or all of their property. For example, an individual normally waits until the day before a foreclosure sale to seek Bankruptcy advice where had they sought advice earlier; their chances of saving the property would have been greatly improved.
2. If an individual files Bankruptcy, his/her credit will be ruined and (s)he will not qualify for credit in the future.
A blatant lie! The fact that an individual files for Bankruptcy will appear on the individual's credit report for up to ten years. While this may seem draconian, this is not as bad as it may first appear.
First, if an individual is considering filing Bankruptcy, their credit is probably not that great to begin with. Filing Bankruptcy may be their best bet to "get good credit" again. Why you ask? The rationale is simple. When a Debtor files for Bankruptcy under Chapter 7 of the Bankruptcy Code and receives a discharge (footnote 3), a Debtor cannot receive another discharge under Chapter 7 for at least eight (8) years.
Lets pretend you are the head of a credit card company in charge of deciding to whom to extend credit and you have two identical applicants with one exception, one of the applicants filed Bankruptcy three months ago. Who would you extend credit to? Applicant #1 who never filed for Bankruptcy and who could file Bankruptcy at any moment after taking your money thereby discharging your debt? Or would you extend credit to Applicant #2 who filed for Bankruptcy three months ago and who recently received a discharge under Chapter 7 of the Bankruptcy Code thereby insuring that your loan cannot be discharged under Chapter 7 for at least the next eight (8) years?
The answer is simple, in the above hypothetical, the person who recently filed Bankruptcy is the better credit risk because an individual can receive only one discharge under Chapter 7 every eight (8) years. This, in reality results in the individual who filed Bankruptcy receiving dozens of new credit card offers within weeks of filing Bankruptcy!
3. If a person files Bankruptcy, they cannot buy a house in the future.
Another lie! All banks are willing to take risks with people who filed Bankruptcy if they have enough security. This normally means a higher interest rate but remember the bottom line here: banks are looking to make money. If a person who filed Bankruptcy in the past applies for a mortgage and that individual has a sufficient down payment, banks will be tripping over themselves to give them a mortgage.
4. If a person owns a home and files for Bankruptcy, they will lose the house.
Yes and no. An individual in the five boroughs of New York, Long Island and Westchester is allowed to keep the first $150,000 in equity in their homes above all liens and encumbrances despite the Bankruptcy filing (the exemption is $300,000 for married couples filing Bankruptcy together). This is called the "homestead exemption." Lets look at a couple of common scenarios:
"The individual is current on the mortgage, there is little equity in the property and has a lot of credit card debt." Let's assume that the property is worth $650,000 and there is a mortgage of $500,000 on the property. In this instance, that individual can file for Chapter 7 and still keep their house.
Let's change the facts a bit. Let's say the same house is worth $650,000 but the individual has a $400,000 mortgage on the property. After we take into consideration the $150,000 homestead exemption, the individual is left with $100,000 in non-exempt equity. If this individual files for Chapter 7, the Chapter 7 trustee (footnote 4) will sell the property and the individual will be given the first $150,000 from the proceeds of the sale. The point that needs to be emphasized here is that the individual will lose the house under Chapter 7 unless after the filing of the Bankruptcy the individual can come up with $100,000 to pay the trustee the non-exempt equity. These funds can come from a post-bankruptcy mortgage or a loan from family and/or friends.
Next example: "The individual is behind on their mortgage, there is substantial equity in the property and has lots of credit card debt." In this example, assuming there is money left over each month after paying the regular monthly bills (the mortgage payment not including arrears, gas, electricity, food, etc.), if this left over money can satisfy the arrears on the mortgage over a period of not to exceed five years, the individual may be able to keep the house in under Chapter 13. Chapter 13 is quite complicated but its principle is simple. As long as the individual repays the debt, they can keep the property. This may be an oversimplification but the point to remember is there are options.
5. Taxes cannot be discharged in Bankruptcy.
Wrong! Certain taxes are dischargeable in Bankruptcy such as certain personal income taxes that are more than three years old if certain requirements are met. As a general rule, fiduciary taxes (e.g. - sales taxes) are not dischargeable. The Bankruptcy Code's provisions relating to taxes are quite complex and differ depending on the Chapter filed under but suffice it to say, certain taxes are dischargeable.
6. Student loans are non-dischargeable.
Generally speaking this is true. However, like every other rule there are exceptions. If the Debtor can prove certain hardship, student loans can be eliminated in Bankruptcy. This is normally an uphill battle but certainly not impossible.
7. An individual can file for Bankruptcy but not include certain creditors in the Bankruptcy.
Wrong! One of the principles behind the Bankruptcy Code is to treat similarly situated creditors equally. When a Debtor does not list a creditor in their Bankruptcy and decides to pay that creditor back, that Debtor is prejudicing the other creditors. If a Debtor does this, the Court considers this fraud and the Debtor can risk losing their discharge and in extreme circumstances face jail time as well as a hefty fine. Don't do it!
8. If I have to list all creditors in the Bankruptcy, I will end up cheating my mom by discharging the money she loaned me.
Although a Debtor must list all their creditors in the Bankruptcy; in certain instances the Debtor can repay a creditor after the Bankruptcy is filed. This is commonly known as a "Reaffirmation." All reaffirmations are subject to court approval. The reason most Debtors agree to pay back a debt they have no legal obligation to pay is to maintain an existing business relationship. In our example, the court would likely approve the reaffirmation if the Debtor lives with mom and worries that mom may throw him out.
9. I signed a piece of paper stating I cannot get rid of this debt in Bankruptcy and I am therefore stuck with it forever.
This is yet another scare tactic. Although the Bankruptcy Reform Act of 2005 has modified this somewhat, there are state law remedies available. Consult with your Bankruptcy Attorney about these provisions.
10. I could lose my job if I file for Bankruptcy.
If you lose your job, you can sue your boss! The law states that if an individual can prove that an employer fired an employee solely because the employee filed Bankruptcy, the employee can sue the employer. As a caveat, if the Debtor/employee looks for another job after the filing of the Bankruptcy, the potential employer can use the Bankruptcy filing as a factor (not the sole factor) in deciding whether to grant that individual employment.
As the above information indicates, there are lots of misconceptions about Bankruptcy.
Neil E. Colmenares, Esq.
Footnote 1 - A "Debtor" is an individual or entity that owes money. The Bankruptcy Act of 1898 which was replaced by the Bankruptcy Code of 1978 substituted the term "Bankrupt" for "Debtor." One of the reasons for this change in nomenclature was to help remove some of the social stigma involved in filing Bankruptcy. Remember, we are all Debtors.
Footnote 2 - For a complete list of exemptions for Debtors who are domiciled in New York, see the New York CPLR Sections 5205 and 5206, New York Debtor and Creditor Law Sections 282 - 285 and the New York Insurance Law Sections 3212 - 3213 and the United States Federal Exemptions located in Title 11.
Footnote 3 - A discharge is a court injunction relieving the Debtor of the obligation to repay most debts and preventing creditors from collecting for same.
Footnote 4 - A "Trustee" is a person appointed by the Court to administer the Debtor's estate. The Trustee's main function is to sell the Debtor's non-exempt property and use the proceeds to pay creditors.
This article is purely a public resource of general information and it is not intended to be nor is it a source of legal advice. You should consult an attorney for advice regarding your specific situation. This communication does not create an attorney-client relationship.
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