What Not to Do Before Bankruptcy

When you're experiencing financial stress, it's tempting to do whatever it takes to alleviate the pressure. But most people find that filing for bankruptcy goes more smoothly with some planning. If you're considering bankruptcy, it's important to learn what not to do before filing for bankruptcy.

Below is a comprehensive list things to avoid before bankruptcy and a brief explanation detailing why you won't want to file at the wrong time, use retirement funds unnecessarily, prepare bankruptcy paperwork carelessly or incorrectly, purchase luxury goods and services on credit or take cash advances, sell or transfer property for less than the value, pay only your favorite creditors, file before receiving a valuable asset, like an inheritance, and fail to file your tax returns.

Also, to avoid choosing the wrong bankruptcy chapter, consider learning about the differences between Chapters 7 and 13.

Don't Rush Into Bankruptcy Too Quickly

Bankruptcy works well to wipe out debt. However, you're only entitled to receive a bankruptcy discharge, the order that wipes out your debt, every so often. So it's a good idea to examine whether now is the time or if you might need to file in the future. Specifically, you can receive a Chapter 7 discharge:

• once every eight years, or
• six years after a Chapter 13 bankruptcy filing.

So why would you want to wait? You might know there's a good chance you'll encounter an even more serious financial issue in the future. For example, if you're battling an illness and accruing medical debt, you'll likely want to delay action until your condition stabilizes. Other common challenges to consider before filing include potential unemployment, eviction, foreclosure, and car repossession.

In these situations, if you have already filed for Chapter 7 bankruptcy within the past eight years, you wouldn't be entitled to another discharge. A creditor could garnish your wages (take money out of your paycheck), levy (seize) the funds in your bank account, or take valuable property without the threat of bankruptcy.

Less effective Chapter 13 bankruptcy options might be available. However, depending on how long it has been since you filed for Chapter 7, you might not be eligible for another discharge. You could still utilize Chapter 13, but you would need to repay all of your debts over a three- to five-year repayment period. Additionally, you would need sufficient income to qualify.

Learn about the timing involved in multiple bankruptcy filings to know when you can file again.

Don't Wait Too Long, Either

However, at times, it is wise to file for bankruptcy quickly. For example, if you face wage garnishment, the sooner you file, the sooner it will cease. Once you discharge the underlying debt, you'll have more money available to pay bills.

You should also file promptly when a creditor has a lawsuit against you. Your attorney will review the complaint to see if it includes an allegation of fraud. If it does, your best option is to file for bankruptcy before the case reaches judgment. While you can discharge monetary judgments in bankruptcy, eliminating a judgment lien can be more challenging.

Once a creditor wins a money judgment, the lien rights that accompany it allow the creditor to garnish your wages, attach your bank accounts, repossess your car, and foreclose on your house. In most cases, if you file for bankruptcy before the creditor wins the case, the bankruptcy will halt the pending lawsuit and eliminate the debt.

You should be aware that bankruptcy provides limited protection against liens, so it's generally advisable to file your case before the creditor obtains a judgment and liens attach to your property. Since this is a complicated area, if you've been served with a lawsuit, it's important to contact a bankruptcy lawyer as soon as possible.

Learn more about your rights when dealing with debt collection.

Don't Drain Your Retirement Account

You can protect most retirement funds during bankruptcy. Therefore, one of the most unfortunate financial mistakes to avoid before filing for bankruptcy is withdrawing retirement funds to pay off a debt that bankruptcy could eliminate.

Before paying off bills in this way, consult a bankruptcy attorney. You will likely find yourself in a much better financial situation if you file for bankruptcy before exhausting your nest egg.

Don't Rack Up New Debt

If you accumulated debt during the 70 to 90 days before filing for bankruptcy, proceed with caution unless the debt was incurred for essential living expenses, such as food, clothing, and utilities. Creditors might challenge your discharge by arguing that you took out the loan without the intention of repaying it (this is known as fraud). Generally, if you obtained cash advances or used a credit card to purchase luxury items within 70 to 90 days before filing for bankruptcy, you might have committed "presumptive fraud" and could be ineligible to discharge that debt.

For the most current presumptive fraudulent debt amounts, see Recent Luxury Debts and Cash Advances: Can You Get Rid of Them in Bankruptcy?

Don't Move Assets

While the bankruptcy schedules require you to provide information about assets you own, some people might be tempted to sell, transfer for safekeeping, or hide assets before filing for bankruptcy. Don't do it. If you do, you might be denied a discharge and even be subject to criminal penalties—and it's unlikely that the risk will be worth any perceived reward.

Of course, you might have sold property before you filed your bankruptcy case to pay your expenses, such as your rent, food, or utilities, and doing so isn't wrong on your part. Be prepared to explain all of your transactions to the bankruptcy trustee and, when appropriate, provide supporting documentation.

For valuable prefiling information, see Preparing for Bankruptcy: What to Do With Bank Accounts, Automatic Payments, and Utility Deposits.

Don't Selectively Repay Loans

Paying back loans to friends or relatives within one year of filing or even other creditors within 90 days of filing could be considered a "preferential transfer." A preferential transfer can be "undone" in bankruptcy.

The bankruptcy trustee might initiate an adversarial proceeding to recover the money from the individual or entity to whom you paid, subsequently distributing the funds equally among all your creditors. If you paid an ordinary creditor, this might not concern you. However, you might be affected if the trustee pursues legal action against your mother or sister to reclaim the funds.

For more information, see Adversary Proceedings in Bankruptcy: Preferential Transfers.

Don't File When You Are About to Receive Substantial Assets

You should reconsider filing for bankruptcy if you are about to receive an inheritance (within one year), a significant income tax refund, a settlement from a lawsuit, or repayment of a loan you made to someone else. Why? Because once you receive the funds, you might not be bankrupt, especially if you could use this money to settle with creditors and get out of debt on your own. If you are in this situation, consult a bankruptcy attorney to discuss your options.

Discover the consequences of hiding assets and property in bankruptcy.

Don't Fail to File Income Tax Returns

If you aren't required to file tax returns, for instance, if you receive disability insurance, you don't need to worry about this requirement in a Chapter 7 bankruptcy. However, if you're supposed to file taxes but haven't done so for the two years before filing bankruptcy, you'll run into problems.

Your tax returns are crucial to determining your current and past earnings and asset holdings, and satisfying potential priority tax claims. Without your returns, completing your paperwork and (if applicable) a Chapter 13 plan will be next to impossible and will stop your bankruptcy. For instance, there's no way for the IRS to determine your tax obligations without a tax assessment.

Don't Provide Inaccurate, Incomplete, or Dishonest Information

On your bankruptcy paperwork, you must provide complete and accurate information about your assets, debt, income, expenses, and financial history under penalty of perjury. Suppose you knowingly misrepresent your information by failing to disclose an asset. In that case, you could be subject to criminal fraud penalties, including fines of up to $250,000, twenty years in prison, or both.

If you don't file all of the paperwork, the bankruptcy court will dismiss your case, or you might have to file additional papers to correct the paperwork and pay more fees. If you leave a creditor out, that debt might not get discharged. And, if you forget to include an asset, the Chapter 7 trustee might find it and take the property.

The Federal Bureau of Investigation (FBI) investigates bankruptcy fraud and crimes, so bankruptcy court is not the place to be less than forthright. Most bankruptcy lawyers can find an appropriate solution to your problem. If you're unsure about your actions' potential ramifications, talk to a bankruptcy attorney first.

If you have already made one or more of these errors, consult a bankruptcy attorney to discuss how to proceed.

Bankruptcy Disclosure Requirements

Filing for bankruptcy is a transparent process. Even though you can keep (exempt) the things you'll need to work and maintain a household, your creditors have a right to everything else. You must agree to disclose every aspect of your financial situation in your bankruptcy paperwork before receiving bankruptcy benefits.

The court ensures creditors get their share by examining up to ten years' prior financial transactions. Everyone who files for bankruptcy, individuals and businesses alike, will report previous transactions on Your Statement of Financial Affairs for Individuals Filing for Bankruptcy form and include it as part of the official paperwork filed with the clerk. (Legal professionals often refer to this as the "SOFA" form.)

So, how might this be problematic? Suppose the court discovers that you transferred property to avoid paying a creditor or broke another bankruptcy rule. In that case, the court will unwind the transaction and disperse the recovered funds to the creditors.

Here's a sampling of the information you'd need to include:

• the source of prior income
• payments you made before filing for bankruptcy
• previous and ongoing legal actions, repossessions, and foreclosures
• gifts and contributions given to others
• losses from theft, fire, other disasters, and gambling
• property transfers
• closed, sold, moved, or transferred financial accounts
• safe deposit boxes and storage units
• things that you're holding for someone else
• any environmental issues you might know about your property, and
• the status of previous and ongoing businesses.

Once complete, you must sign a statement declaring under penalty of perjury that the information provided is accurate. Being forthright is essential because any attempt to defraud the court has severe consequences. The punishment for making false statements or failing to disclose property can be up to 20 years in prison, a fine of $250,000, or both.

Learn more about filling out bankruptcy forms.

Need More Bankruptcy Help?

Did you know Nolo has made the law accessible for over fifty years? It's true, and we wholeheartedly encourage research and learning. You can find many more helpful bankruptcy articles on Nolo's bankruptcy homepage. For instance, Nolo articles will explain what bankruptcy can do, what you'll want to avoid before filing for bankruptcy, and more. Information needed to complete the official downloadable bankruptcy forms is on the Department of Justice U.S. Trustee Program website.

However, online articles and resources can't address all bankruptcy issues and aren't written with the facts of your particular case in mind. The best way to protect your assets in bankruptcy is by hiring a local bankruptcy lawyer.