If you use your credit card to buy luxury goods before you file bankruptcy, you run the risk of having to repay the debt.
Although credit card debt is usually dischargeable in bankruptcy, under certain circumstances, the credit card company can file an action within a bankruptcy case to declare its debt nondischargeable. Purchasing luxury items or services within 90 days of filing for bankruptcy is one of those situations where the credit card company is likely to challenge the dischargeability of the debt.
(There are other ways to jeopardize your credit card debt discharge in bankruptcy. See Credit Cards and Bankruptcy to learn more.)
What Is the Bankruptcy Discharge?
When you file Chapter 7 or Chapter 13 bankruptcy, the end result you seek is a discharge of your debts. A discharge in bankruptcy means that your personal liability on any dischargeable debts you had at the time you filed bankruptcy is wiped out. The debts still exist, but you are no longer legally obligated to pay them back. Once the court enters your discharge, your creditors will receive a copy of the discharge and will have no choice but to write off your account. When a debt is discharged, it cannot be collected.
Some debts are dischargeable, and some are not. Congress drafted the bankruptcy laws to protect certain types of creditors and prevent people who file for bankruptcy from exploiting the law. (Learn about different types of dischargeable debts in bankruptcy.) Credit card debts are generally dischargeable debts. A Chapter 7 will wipe out all your credit card debt, and a Chapter 13 will only require you to pay a percentage. However, credit card debt can be made nondischargeable if the credit card company can show the court that you committed fraud or are abusing the system.
What if You Use Your Credit Card for Luxury Purchases Before Filing Bankruptcy?
If a credit card company can make a case to the bankruptcy court that you incurred your credit card debt fraudulently, the court can enter a judgment declaring the debt nondischargeable. Bankruptcy law recognizes two basic types of fraud:
- actual fraud, and
- constructive fraud.
Actual fraud. Actual fraud occurs when the debtor (the person who filed bankruptcy) used the credit card with actual intent to defraud the credit card company. An example of this is when a debtor, knowing he or she will be filing bankruptcy, runs up the balance on the credit card, buying things essentially for free. Actual fraud is difficult to prove, and most nondischargeability actions are based on constructive fraud.
Constructive fraud. Constructive fraud occurs when the debtor does not necessarily have the intent to defraud, but the nature of the debtor's actions are such that fraud is implied or construed.
In bankruptcy, fraud is presumed when the debtor uses a credit card to make luxury purchases of $600 or more during the 90-day period before the bankruptcy filing. This means that if you use your credit card to buy $600 or more of luxury goods or services within the 90 days before the date you file bankruptcy, the creditor can sue for nondischargeability based on constructive fraud. Because the purchases are presumed fraudulent, the burden is on you to show that they are not.
What are Luxury Purchases?
Any goods or services you purchase with your credit card that are not reasonably necessary for the maintenance and support of you and your dependents are considered luxury goods and services. Fur coats, jewelry, home decor, makeup, hair products, manicures, plane tickets, salon services, alcohol and electronics are just a few of the items and services that are considered luxury purchases under bankruptcy law.
If you make these types of purchases within the 90 days before you file bankruptcy and the credit card company sues, you will have to prove to the court that these purchases were reasonably necessary for your maintenance and support.
Example 1. Carl used his credit card to buy an engagement ring for his girlfriend, spending $5,000. Carl filed Chapter 7 bankruptcy 45 days after buying the ring. The credit card company sued for nondischargeability. The court would likely find that the engagement ring was a luxury purchase and force Carl to repay the debt, despite the fact that he had no intention of filing bankruptcy at the time of the purchase. Carl may be able to defend against the suit if he can prove he intended to repay the debt and made a good faith effort to do so before filing his case.
Example 2. Jane has a very low income. One day, her car breaks down. She finds out she needs a new transmission. She cannot afford to pay the $900 repair bill, but she needs the car to go to work, so she uses her credit card to pay for the repair. A court would likely find that this was a reasonably necessary expense, and therefore allow the discharge of the credit card debt.