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 a bankruptcy case goes more smoothly with a bit of planning. If you're considering bankruptcy, you won't want to do the following things:

• 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 it's worth
• pay only your favorite creditors
• file before receiving a valuable asset, like an inheritance, and
• fail to file your tax returns.

Finally, to avoid choosing the wrong bankruptcy chapter, take time to learn 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 whether 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 find yourself facing an even more severe financial problem during the waiting period. For instance, if you're suffering from an illness and accumulating medical debt, you'll probably want to hold off until your condition stabilizes. Also, be aware of other common problems that can crop up, including unemployment, eviction, foreclosure, and car repossession.

If you'd already filed for Chapter 7 bankruptcy, you wouldn't be able to do so again. A creditor could garnish your wages (take money out of your paycheck), levy (seize) the funds in your bank account, or take valuable property.

Less effective Chapter 13 bankruptcy options would likely be available. However, depending on how long it had been since you filed Chapter 7, you might not be entitled to another discharge. You could still use Chapter 13, but you'd have to repay all of your debt over a three- to five-year repayment period. And you would need sufficient income to qualify.

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

But Don't Wait Too Long, Either

However, sometimes it's in your best interest to file for bankruptcy quickly. For instance, in most cases, if you have a wage garnishment in place, the sooner you file, the more money you'll have to pay bills.

You'll also want to file quickly when a creditor has a lawsuit against you. Your attorney will examine the complaint to determine whether it includes a fraud allegation. If so, the best bet will likely be filing for bankruptcy before the case goes to judgment. Because even though you can discharge money judgments in bankruptcy, getting rid of a judgment lien in bankruptcy can prove more difficult.

Also, once a creditor wins a money judgment, the lien rights that accompany it will 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 stop the pending lawsuit and wipe out the debt.

You should be aware that bankruptcy offers limited protection against liens, so it's usually good to file your case before the creditor receives a judgment and liens attach to your property. Because this is a complicated area, if you've been served with a lawsuit, you should 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 in bankruptcy. Therefore, one of the most unfortunate financial mistakes people regularly make before filing for bankruptcy is withdrawing retirement funds to pay off a debt that bankruptcy could wipe out.

Before paying off bills in this manner, speak with a knowledgeable bankruptcy attorney. You'll likely find yourself in a much better financial situation if you file for bankruptcy before depleting your nest egg.

Don't Provide Inaccurate, Incomplete, or Dishonest Information

On your bankruptcy paperwork, you're required to provide complete and accurate information about all of 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.

Don't Rack Up New Debt

If you ran up debt during the 70 to 90 days before filing bankruptcy, beware unless it was for life necessities, such as food, clothing, and utilities. The creditor might object to your discharge by arguing that you took out the loan without any intention of paying it back (called fraud). As a general rule, if you took out cash advances or used a credit card to buy a luxury item within 70 to 90 days of filing bankruptcy, then you've committed "presumptive fraud" and might not get to discharge the 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 ask that you provide information about assets you own (or will own), some people might be tempted to sell, transfer for safekeeping, or hide assets before filing 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 more information, see Hiding Assets and Property in Bankruptcy.

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. So you must agree to disclose every aspect of your financial situation in your bankruptcy paperwork before receiving the benefits of bankruptcy.

The court ensures that creditors get their share by examining up to ten years' worth of 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 in an attempt 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 sources of your 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 comes with 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.

Don't Selectively Repay Loans

If you pay back loans to friends or relatives within one year of filing, or even other creditors within 90 days of filing, then this may be considered a "preferential transfer." A preferential transfer can be "undone" in bankruptcy.

The bankruptcy trustee might file an adversarial proceeding to get the money back from the person or entity you paid and then disburse the funds in equal shares amongst all of your creditors. If you paid an ordinary creditor, that might not matter to you. However, you might care if the trustee sues your mom or sister to get the money back.

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 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 find yourself in this situation, consult with a bankruptcy attorney to discuss your options.

Don't Fail to File Income Tax Returns

If you aren't required to file tax returns—for instance, 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, as well as 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 in its tracks. For instance, there's no way for the IRS to determine your tax obligations without a tax assessment.

If You Make a Mistake

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

Need More Bankruptcy Help?

Did you know Nolo has been making the law easy for over fifty years? It's true—and we want to make sure you find what you need. Below you'll find more articles explaining how bankruptcy works. And don't forget that our bankruptcy homepage is the best place to start if you need anything else!

Providing all information needed to file for bankruptcy is beyond the scope of this article. If you'd like to file without an attorney, a self-help book like How to File Chapter 7 Bankruptcy by Attorney Cara O'Neill and Albin Renauer J.D. or Chapter 13 Bankruptcy: Keep Your Property & Repay Debts Over Time, by Cara O'Neill (Nolo) can help you make well-informed decisions about your bankruptcy matter.