Bankruptcy: Mistakes to Avoid
What common mistakes are made when filing bankruptcy?
Read about thees mistakes to avoid before filing bankruptcy! Here’s what NOT to do as you are trying to fix your debt problems.
You are here because you are searching for answers, solutions to you debt problems.
You may be just beginning your search, or in the final stages of deciding what to do.
Wherever you are in your journey, there are big, big mistakes you need to avoid.
These are NOT obvious.
I want to help keep you safe.
Help you avoid creating trouble for yourself unknowingly.
And, there’s a lot you need to know.
Most of the mistakes before filing bankruptcy that I see people make are totally understandable
And totally avoidable.
They do completely legal things, with good intentions.
Things they THINK will help them, but later learn create sometimes horrible, un-fixable problems.
Problems that prevent them from getting the help they need.
I see this all the time.
People come to me AFTER they have done these things and I have to tell them that they just shot themselves in the foot, and made a bad situation even worse.
But – preventable!
Here are mistakes to avoid before filing for bankruptcy.
The number one most dangerous mistakes to avoid before filing bankruptcy is making preferential transfers.
“What the heck is a preferential transfer?” you ask.
This is “legalease” for paying money to, or for the benefit of “insiders.”
“Ok,” you say, “So what is an insider and can you give me an example?”
This happens all the time. (Especially around tax refund time)
When you’re struggling with debt, and can’t keep up, often family helps out.
Perhaps not a family member, but a friend, or business associate.
An “insider” is anyone with whom you have a relationship that is more than a normal creditor.
We see family loans regularly, and it makes sense that your family would want to help you out if they can, if you’re struggling to keep up with your bills.
So, when someone decides to file bankruptcy, they will often stop paying any credit card, medical bills or other unsecured debts.
When they do this, they often have some extra money, and the first thing they want to do is pay back the family member who loaned them money to help them out.
DON’T DO IT!
If you file a bankruptcy, it is “OK” to OWE family.
It is not “OK” to PAY family.
In fact, family members are treated more harshly than ordinary creditors by bankruptcy law.
More details . . .
One of the questions you will be asked by a trustee when you file for bankruptcy is whether or not you have paid any of your creditors more than $600 in the 90 days before you filed your bankruptcy case.
This is to prevent one creditor from receiving more money than any other creditors before you file.
The idea is that you should not be permitted to “prefer” one creditor by paying that creditor money, then filing bankruptcy and the rest of your creditors get nothing.
That’s why it’s called a “preferential transfer” because you have transferred an asset – made a payment – to a creditor and this results in their preferential treatment, compared to all the rest of your creditors.
But, for family members, the “look back” period is a full YEAR, not just 90 days.
The reason is obvious.
We will always “prefer” our family to non-family.
If money is tight, and there’s not enough to go around, then family debts get paid first, or “preferred” to other, non-family members.
Solution: Pay back family debts, if you owe any, AFTER you file your bankruptcy case.
Payments made to family members or other “insiders” AFTER filing your case are not considered preferential payments.
Don’t “put it in some else’s name” so you don’t have to list it in bankruptcy
Don’t put anything you own into someone else’s name. Sometimes people think that it’s a good idea to get things out of their name before they file a bankruptcy. This almost always causes significant problems. Its common of mistakes to avoid before filing bankruptcy.
In fact, transferring a car, motorcycle or a house out of your name prior to filing bankruptcy prevents you from using your exemptions to protect the property.
It actually works against you.
Example: I once had a client who was afraid he would lose his motorcycle if he filed bankruptcy. The motorcycle was worth $5000 and he owned it free and clear. To protect the motorcycle, he transferred it to his brother so that he wouldn’t have to claim it as property he owned in the bankruptcy.
What he didn’t understand was that we are required to disclose all transfers made in the two years prior to filing a bankruptcy.
And, the trustee will often ask about transfers within the last 4 years prior to filing bankruptcy.
If he had simply left the motorcycle in his name, I could’ve easily protected it with his bankruptcy exemptions.
Your bankruptcy exemptions only protect property that you own. Since he no longer owned the motorcycle he couldn’t apply his exemptions to protect it. If he filed his bankruptcy after the transfer, this is what will happen:
- The bankruptcy trustee would be required to recover the motorcycle from the brother,
- The debtor in bankruptcy would not be able to protect the value of the motorcycle since it wasn’t owned at the time the petition was filed,
- The trustee would sell the motorcycle and distribute the money to the debtor’s creditors.
There’s more to know here.
In Ohio, bankruptcy trustees are able to go after transfers up to four years prior to the filing of the bankruptcy in many cases. And if this wasn’t bad enough, there is a particular situation which arises occasionally that allows trustees to go back 10 years.
How can we fix these?
Sometimes we can, sometimes we can’t fix them.
When we can, this normally involves “undoing” the transfer. So if I paid my parents back $1,000 and this causes a preferential transfer problem, I could ask them to give me the $1,000 back.
Sometimes we can’t fix the problem.
When this happens, we may have to “wait it out” until the transfer look back time runs out.
Does this mean that you can never file bankruptcy if you have transferred property to an insider in the preceding four years?
No. I file cases with transfers all the time.
Although the application of the law is sometimes complex and depends heavily on the individual circumstances and transaction, not all transfers to insiders create problems.
This is one of the most common mistakes to avoid before filing bankruptcy.
If I sell my car worth $5000 to my family member or best friend, for $5000, this is a transfer but not preferential.
The reason it’s not preferential is because I received what the car is worth. And, the transfer of the car is done at the same time that I got the money for the car.
I borrow $5000 from my friend, and then several months later, shortly before filing bankruptcy, I get my tax refund and pay my friend back $5000. This is clearly a preferential transfer. The debt was owed for several months before I paid him back. The “legalease” for this is “payment on an antecedent (pre-existing) debt.
Taking out loans prior to filing bankruptcy.
When you are experiencing financial difficulty, it is very common to rob Peter to pay Paul.
Cash advances on credit cards and payday loans are commonplace.
Finance companies such as One Main and Mariner Finance make loans at relatively high interest rates both secured and unsecured.
Taking out loans and then filing bankruptcy shortly thereafter can create problems. Sometimes creditors will sue you in your bankruptcy and ask the court to declare that your loan was taken out with the intent to defraud them.
Creditors claim that you took the loan out without any intent to pay it back.
In my experience, this is seldom the case.
Most of the time people take out these loans because they have no other choice!
They are desperately trying to either keep their payments current, in many cases to maintain their credit score, or, their situation is so bad that they need to borrow money in order to pay living expenses.
When you have taken out loans, you need to be really careful about the timing of your bankruptcy filing. If you file too soon after taking the loans you increase your chances of having problems in your bankruptcy. Timing issues are one of the more mistakes to avoid before filing bankruptcy.
Balance transfers prior to filing bankruptcy
Bankruptcy trustees often ask whether or not you have done any balance transfers or if you’ve taken out any new loans in the preceding 3 to 12 months before you found your bankruptcy. And, of course, they want to know what you did with the money.
While these may not have any direct effect on you, if your trustee sees this kind of activity, the trustee may seek to recover balance transfers and this could hold your case open for months.
Adversary Proceedings – Getting sued by your creditors in your bankruptcy
The lawsuits that creditors file against consumers who file bankruptcy under these circumstances are called adversary proceedings. Essentially you’re being sued in your bankruptcy by the creditor who wants to escape the debt being discharged.
Adversary proceedings often cost more to defend than your attorney will charge for the bankruptcy itself. The stress that consumers experience when they are sued in adversary proceedings in their bankruptcy is tremendous. And, of course, the additional cost of adversary proceeding is generally something that most people cannot afford.
By paying attention to these mistakes to avoid before filing bankruptcy, you will reduce the risk that you get sued in your bankruptcy case.
Tax refunds in bankruptcy
Your tax refund is a property right that must be listed in your bankruptcy.
The problem is, in many cases, you don’t know what your tax refund is going to be until you file your taxes and sometimes you don’t have the luxury of time in your bankruptcy so that you can receive your refund and properly spend it prior to filing.
Fortunately, not all of your tax refund can be taken by the trustee.
If your tax refund is partly earned income credit or additional child tax credit, these amounts are not part of your bankruptcy and can’t be taken by a trustee no matter how large they are.
I’ve had a number of cases where my clients got tax refunds approaching $10,000 – mainly earned income credit and additional child tax credit.
They filed Chapter 7 and discharged all of their unsecured debt and kept their entire tax refund.
Most of the time, however, there is some portion of the tax refund that is not protected. There is no special protection for tax refunds in bankruptcy.
But, you have a “wildcard” exemption of $1500 and a cash exemption of $500 which can be combined to protect your tax refund up to $2,000 ($4,000 for a married joint bankruptcy).
Sometimes, people think that if they file their bankruptcy before they receive their tax refund, then they don’t have anything to worry about.
This is a big mistake. Totally not true.
The right to receive the tax refund is something that accrues during the year as you pay your taxes. So, even though you’re not able to receive the tax refund until after you file your taxes the “right to receive” the refund is property of your bankruptcy case.
Someone is going to receive a very large refund that is not protected. They file their bankruptcy at the end of September, ¾ of the way through the year.
Since they won’t get their refund until the following year, they may think that their tax refund is safe. Not so.
In this example, by filing at the end of September 75% of the tax refund they will receive after they file is subject to the bankruptcy trustee control.
Trustee will only allow you to keep 25% of your tax refund, plus whatever portion of your wildcard in cash on hand which would apply to the remainder (up to $4,000 for a joint case, as explained above).
The trustee can actually reopen your bankruptcy case, if he later finds out that you got a big enough refund (after you apply your exemptions.
Not paying attention to these tax issues is common of mistakes to avoid before filing bankruptcy.
Spending sprees prior to filing bankruptcy
We have all seen stories about people who get into serious problems because they ran their credit cards up, maxed them all out, even took out new ones, prior to filing a bankruptcy. These stories are sensational and make the news – but are actually extremely rare.
In fact, having handled over 20,000 clients in the last 33 years, I can tell you that I have yet to see a single case where someone intentionally runs up a lot of debt with the idea that they will discharge it in a bankruptcy.
Most of the time, just the opposite is true!
I see people go to extraordinary lengths to try to pay their debts. They make personal sacrifice, go without medication, go without food, and cut their expenses drastically trying to make ends meet.
Nevertheless, creditors are always on the lookout for any unusual spending pattern prior to filing bankruptcy. Also, bankruptcy cases are audited by United States trustee’s office and the United States trustees also look for unusual spending patterns prior to bankruptcy.
Unusual spending may actually be necessary and unavoidable. For example, when someone has no insurance and needs medical attention it may be necessary to borrow money in order to pay for prescription drugs or medical treatment.
Once I represented a man who had no insurance. He was self-employed, and his wife became very ill with cancer. Because he had no insurance, his only means of obtaining the necessary medical treatment that his wife needed was to pay for the medical bills with credit cards.
Over the course of several years, he charged over $100,000 on his credit cards to pay for his wife’s care. After she passed away, he was forced to file bankruptcy.
The large amount of spending was detected by the United States trustee’s office who audited my client. The audit was detail and went on for several years.
Ultimately, we were able to establish that the spending was necessary under the circumstances in my client was able to receive a discharge.
So, if you have had to make unusual charges in the year prior to filing a bankruptcy – we need to discuss this so we can get you through to your discharge safely. It’s important that we be ready for an audit. All of the facts need to be reviewed and properly disclosed.
Personal injury and accident cases
Your right to keep money you are awarded as a result of being injured in an automobile accident or otherwise suffer personal injury is protected up to $25,000 in a bankruptcy.
This is limited to damages related to the personal injury.
It doesn’t matter that your settlement may take years – and that your bankruptcy could be over before you finally settle, or try, your case.
But – you can lose your case before you begin!
Screwed up bankruptcy filings are sure-fire windfalls for the people who harmed you.
If not handled correctly, you will lose the right to pursue your accident claim.
It is very important to disclose the fact that you may have a claim in your bankruptcy papers when you file. If you fail to do this, you could lose the right to sue for your injuries.
Sometimes, after an accident, you might not think you are injured or you might not think that you will ever pursue a lawsuit to recover money for the accident. If this slips your mind and you do not tell your lawyer about it, and your claim is not properly listed in your bankruptcy petition, you can lose the right to sue and recover.
Taking out loans with credit unions.
Many people use credit unions instead of banks. Credit unions tend to be small local financial institutions and often it is easier to get alone with a credit union than with the bank. Credit unions offer car loans, unsecured loans, and credit cards.
Credit unions are great. Easy to work with.
Until they’re not.
And they’re not particularly “bankruptcy friendly.”
If you are having financial problems, and if you bank with a credit union, it may be tempting to apply for an unsecured loan or a credit card with the credit union.
You might also have a car loan with credit union. Or a credit card.
If you think that your situation is serious enough that you may need to consider filing a bankruptcy, you should avoid taking out loans with credit unions. The reason for this is because all credit unions cross collateralized their loans.
Cross collateralization? More legalese! (Sorry- but you need to know this stuff.)
Cross Collateralization is legalese for the process by which credit unions tie the collateral they have for one loan to all of the other loans or credit cards you may have with the credit union.
You have a car loan with your credit union, and you need to borrow money. You go to the credit union and get what you think is an “unsecured loan.” If, later you need to file bankruptcy, you will learn that your “unsecured loan” is not really unsecured. The unsecured loan is also secured by your car.
So, if you want to keep the car and are filing a Chapter 7, you will have to pay the unsecured loan as well as the car loan. In many cases this means that it doesn’t make financial sense to keep the car because the total debt on the car loan and the unsecured loan will often exceed the value of the car.
Credit unions even add the credit card balances that you may have with them to the car loan as well.
Debts with credit unions create unforeseen danger to people with financial difficulties. Because of the cross collateralization, if you miss a payment on your credit card you might find that your car gets repossessed.
The reason for this is the cross collateralization. Even the credit card is secured by the car.
I can’t count the number of times that people come to me totally shocked by the fact that their car got repossessed, adamantly telling me that their car payments were all made on time, never late, and that they are sure that the credit union must’ve made a mistake.
When they tell me that they are behind on their credit card or signature loan, that’s when I explain to them about the cross collateralization.
Getting loans from credit unions prior to filing bankruptcy is a big mistake to avoid.
Borrowing money from retirement plans.
Another bit mistakes that people make prior to filing bankruptcy is either taking distributions from their retirement plans or taking loans against their retirement plans to pay debt. This is almost never a good idea.
In almost every situation, your retirement account is completely protected. 100% protected. Creditors can’t get to it, and neither can a bankruptcy trustee.
If you use your retirement to pay debt . . . debt that would be discharged if you file bankruptcy, you are probably making a huge mistake.
- When you take a distribution from your retirement account, you must pay taxes on it and will probably owe a penalty. So now you have created a new debt with the IRS.
- The money you take out of your retirement account makes your financial future less secure.
- The debts that you are paying with the money you take out of your retirement account are often dischargeable in bankruptcy. And there is no tax debt created by discharging debts in bankruptcy.
Your retirement should never be considered under normal circumstances as a source of funds to pay debt.
Avoid Mistakes before filing for bankruptcy
There are lots of ways to screw up a bankruptcy.
This article highlights the problems that I see regularly, frequently, over and over again.
All of these problems are avoidable.
Before doing anything, you really ought to consult with a bankruptcy attorney to make sure that you don’t inadvertently do something that will cause you problems if you do need to file.