What to Do Before Filing for Bankruptcy

Excerpted from Complete Chapter 7 Personal Bankruptcy Guide by Edward A. Haman ©2007

This section discusses some things you must do, or may wish to do, prior to filing for bankruptcy. It explains some techniques that may be used to help improve your situation, and discusses some serious problems that can be encountered by certain attempts to gain an advantage.

Basic Legal Requirements
Under the 2005 changes to the Bankruptcy Code, there are certain basic requirements that must be met in order to file for bankruptcy. Some of these apply to Chapter 7 cases, some apply to Chapter 13 cases, and some apply to both.

Means Testing
In general, you will not be able to file under Chapter 7 of the Bankruptcy Code unless you meet certain financial requirements. If, under the guidelines established by Congress, your financial means (ability to pay) are too great, you will not be permitted to discharge your debts under Chapter 7. Instead, you will need to work out a debt payment plan under Chapter 13.

First, your family income over the past six months will be examined, and if it falls below the median income for your state, you will be able to use Chapter 7. If it is above the median income, the court will then look at your ability to pay your debts. The judge takes your income, subtracts certain allowable expenses, and determines whether you have enough money left over to pay at least $100 per month to your creditors, and whether you will be able to pay at least $10,000 or 25% of your unsecured debts over a five-year period. If you do have such sufficient leftover money, you will need to file under Chapter 13.

Credit Counseling
Before you can file for bankruptcy under Chapter 7, you will need to see a credit counselor who is approved by the U.S. Trustees Program. This must be done within the six-month period before filing. To find approved credit counseling agencies near you, contact your local bankruptcy court clerk, your local trustee’s office, or go online to www.usdoj.gov/ust.

Financial Management Course
Before your case can be concluded under Chapter 7, you will need to complete a course on financial management given by an agency approved by the U.S. Trustees Program. This does not need to be done before you file, but must be done before the court will discharge any of your debts. To find approved financial management education agencies near you, contact your local bankruptcy court clerk or your local trustee’s office, or go online to www.usdoj.gov/ust.

Arranging Your Finances
There are some things you might do before you file that will improve your situation after your bankruptcy is complete.

– Warning –
Use this section with extreme caution. Before you file for bankruptcy, you may want to review your financial situation to see if there is anything you can rearrange to your advantage. You need to be aware that you may be walking a fine line between acceptable practices and what the court might consider to be cheating your creditors. At a very minimum, you should not file for bankruptcy for at least ninety days after you make any of the changes discussed in this section. If any changes involve a relative, you should not file for at least one year. However, each bankruptcy judge has his or her own ideas and attitudes, and some have determined that there was an intent to defraud where transfers were made more than a year before filing.

Incurring New Debts
If you will need to borrow more money to pay for necessities (such as for medical treatment, buying clothing for your family, or getting your car repaired so you can get to work), you may want to wait to file for bankruptcy until you have incurred these debts. This way, these debts can be included in your bankruptcy. A bankruptcy only affects those debts that you incur before you file. Any debts you incur after you file are not included in the bankruptcy. Just make sure you are incurring these new debts for necessary things and not for luxuries (such as a vacation, a new stereo, or a night on the town).

Converting Nonexempt Property to Exempt Property
It is permissible to convert nonexempt property to exempt property, provided this is not done with the specific intent to defraud creditors. Whether there is intent to defraud creditors is decided on a case-by-case basis, and is based on the individual circumstances. The big risk here is that if the court determines there was an intent to defraud creditors, it can deny your request for a discharge of your debts. The most obvious thing you could do is sell nonexempt property and use the money to buy exempt property.

Example: If you live in New York, exempt property includes furniture, a radio, a television, a refrigerator, and clothing. However, boats and second cars are not exempt. Therefore, you may
want to sell your boat or second car and use the money you get to buy some furniture, a radio, a television, a refrigerator, or some clothing.

Another possibility is to take money (either from an existing nonexempt financial account or from selling nonexempt property) and place it in some type of exempt investment.

Example: If you live in Florida, there are only minimal exemptions for cash in bank accounts or personal property items. However, Individual Retirement Accounts (IRAs) are exempt. Therefore,
you could put money into an IRA account. There is a court opinion that approved of such a transfer (in the amount of $5,000), even though the money was deposited in the IRA about three months before filing for bankruptcy, the debtors were unemployed, and “their future prospects looked rather gloomy.” (In re Horvath, 116 B.R. 835 (M.D. Fla. 1990).)

Using Nonexempt Property to Pay Certain Debts
It is also permissible to use nonexempt cash, or money from the sale of nonexempt property, to pay off a nondischargeable debt (such as a student loan or overdue taxes) or to pay on a secured debt on exempt property (such as catching up with an overdue mortgage payment).

Example 1: You have a nonexempt boat. You sell it and use the money to pay off a student loan. In the bankruptcy you would lose the boat anyway, so you may as well use it to reduce or eliminate the number of payments you will need to make after bankruptcy on your nondischargeable student loan.

Example 2: You have a nonexempt second car. You sell it and use the money to pay off the balance of the loan for your primary car, which is exempt in your state. You get to keep your primary
car after bankruptcy, and you will have one less payment to make (provided your primary car is not worth more than the allowable exemption).

You may also want to sell nonexempt property to pay off an unsecured loan. Paying an unsecured loan will only be of advantage under one or both of the following circumstances.

 A friend or relative has co-signed the loan and you do not want to stick that friend or relative with having to pay the loan for you.
 You want to maintain good relations with that particular creditor (such as your doctor or car repairman), and possibly be able to keep your ability to buy there on credit.

Bankruptcy Abuse and Defrauding Creditors
Under the 2005 changes to the Bankruptcy Act, if certain facts become apparent from the papers you file, it can trigger a presumption of fraud. One of the forms you will complete and file with the court will analyze whether there is such a presumption of fraud. This will be discussed more in later sections of this book. Even if there is a presumption of fraud, it does not mean there is fraud. However, your case will become subject to greater scrutiny by the trustee, your creditors, and the court.

Rearranging your asset and debt situation can get you into trouble. If it appears to the court that you have made changes in order to cheat your creditors, the judge can let the trustee take and sell the new property you bought. He or she can even dismiss your case and not let you have a discharge of any debts. This will leave you in a much worse situation than when you began. These problems most often occur when it appears that the debtor has incurred significant debts with the idea of declaring bankruptcy in order to avoid paying (such as if you and your spouse charge an expensive Alaskan cruise on your credit card, and then file for bankruptcy shortly after returning home). In order to minimize the chances of problems, keep the following points in mind.

 Do not make so many sales that you would have enough money to pay off most or all of your debts (unless this is your goal in order to avoid bankruptcy). If you sell enough property to be
able to pay off your debts, and then do not pay them off, it will be considered fraud.
 Sell and buy property at market value prices. If you sell something for less than reasonable or market price, or buy something for more than it is worth, your creditors may object.
 Avoid sales to, or purchases from, relatives. If you decide this is absolutely necessary, be sure you make the exchange at market value.
 Do not sell something expensive and buy something cheap, planning to secretly pocket the cash. The judge or trustee can make you account for all of the cash you get from a sale, and then either you come up with the extra cash or get your case dismissed.
 If the trustee, judge, or creditor asks you about your transactions before you filed, tell the truth. One of the main things the court will consider in deciding if your action was fraudulent is your intention. Furthermore, if you are asked about a particular transaction, you can be sure that the person asking the questions already knows about it. Judges do not like people who lie or are
sneaky, so do not try to hide things. You are bound to get caught.
 Do not buy more nonexempt property on credit, then sell the items to buy exempt property. This is fraud.
 Do not go overboard and sell all of your nonexempt property. Leave something for the unsecured creditors so they do not feel cheated and challenge the transactions.

If all of this leaves you confused and you want to take advantage of the things discussed in this section, you should consider consulting a lawyer.