Attorney Jon Ginter
What Can Go Wrong in Bankruptcy?
There are literally hundreds of things that can go wrong in a Chapter 7 bankruptcy. This article concentrates on common amateurish mistakes that people make when they attempt to file bankruptcy without an attorney or with an attorney who doesn't really know what he or she is doing. Most of these mistakes simply lead to your bankruptcy being unsuccessful, but some of them lead to more severe consequences, such as the loss of property. Truly horrendous errors, which do occur from time to time and can lead to prison time or your debts becoming permanent, are covered in my article, "Eight Ways to Ruin Your Bankruptcy, and Maybe Your Life."
Common Mistake #1: Filing a bankruptcy without understanding how it will affect your property (including having "property" taken away that you didn't even know was property)
(for rules about what property you can keep in bankruptcy, read "What Property Can I Keep in Bankruptcy?")
Chapter 7 bankruptcy is sometimes called liquidation, meaning that the court takes away your property, "liquidates" or sells it, distributes the proceeds to your creditors, and wipes out your remaining debt. Luckily with a good attorney you will usually lose little or no property in a Chapter 7, and whatever property you do lose shouldn't come as a surprise, but as something your attorney warned you about before the case was even filed. However, people who file bankruptcy without an attorney or without a good one may be in for some very unpleasant surprises when they go to court.
In the unfortunate event that you do file a Chapter 7 and later learn you stand to lose property you didn't expect to lose, people often think "Oh well, I'll just dismiss my own case and then the court won't take my property away." However, that shows a gross misunderstanding of how the process works. You've put your life under the court's control and the purpose of bankruptcy isn't just to benefit you, but also to benefit creditors by seizing and selling your property so they can get at least some of the money they are owed. The law doesn't allow you to dismiss your case to get out of this happening, period. The court is not only able but required to take your stuff away and if this has the side-effect of ruining your life well, that's just the way the cookie crumbles.
These types of nasty surprises most often affect automobiles and any tax refund you might be getting next year. In the case of automobiles, most automobiles can be protected in bankruptcy by listing in your bankruptcy paperwork the right exemptions, which are sections of the Ohio Revised Code that allow you to protect part of the value of your vehicle in bankruptcy. Sometimes automobile exemptions are pretty straightforward, but they can get very tricky in a joint bankruptcy case or where you failed to verify prior to filing your bankruptcy that your auto loan company "recorded their lien" properly against your automobile (an auto lien is what gives creditors the right to repo your car if you don't pay). Another issue that often comes up is that some auto finance companies will automatically repossess your automobile in a Chapter 7 bankruptcy even if you are current unless you execute a special contract called a reaffirmation agreement. Unfortunately, most people filing Chapter 7 bankruptcy do not have enough income to be eligible to sign a reaffirmation agreement, and if they are dealing with one of these tougher auto finance company they are going to lose their car. A good bankruptcy attorney has experience dealing with different auto finance companies and knows which ones will work with you and which ones will not.
Regarding the tax refund you might be getting the year after filing bankruptcy, people filing bankruptcy often do not list these as property in their bankruptcy paperwork because they do not view them as property. However, even though you don't actually have control over the money, your refund is property because it does belong to you and it is only a matter of time before it comes into your hands. Thus, people often lose at least part of their upcoming tax refund when they file bankruptcy. Fortunately, by claiming the right exemptions and timing the date of your bankruptcy filing in a strategic way, it is usually possible to save all or part of your refund. Other examples of property that people often lose because they didn't realize it was "property" include proceeds of personal injury or other lawsuits, money or life insurance proceeds that may be inherited, and sales commissions and bonuses due to be paid from one's job.
Common Mistake #2: Failing to calculate your income, expenses, or household size properly
Chapter 7 bankruptcy isn't available to just anybody-- you have to be below a certain income threshold based on the number of people in your household. While it may sound simple enough to calculate whether you're under this threshold, it turns out that it's actually quite tricky. In fact, even the rules used to calculate the number of people in your household are poorly defined and subject to dispute: Some judges follow the "heads on beds" approach, which says that the number of people in your household is the number of people who sleep under your roof, while other judges follow the "economic unit" test, which says the number of people in your household is the number of people who are working together financially as one economic unit.
Things become most complicated, however, where the calculation of income in concerned. In order to qualify for bankruptcy, you have to prove to the court that you pass not one but two income tests: the means test and the test of "bankruptcy abuse." The means test is a seven-page form where all of your income and expenses are listed. The tricky part is, the income and expenses are almost never your actual income and expenses. The income portion is not the income you are making today, but every penny that anyone in your household earned in the six-month period leading up to the month you filed bankruptcy, divided by six. Calculation of this figure is sometimes straightforward but can become quite burdensome where there are multiple income earners, multiple jobs or changes in employment and, most of all, cases in which there is business or rental income in the six- month period prior to the month in which you are filing bankruptcy.The expense calculation portion of the means test is even less intuitive: For the most part, you don't get to claim what your real expenses are, but are required to claim the expenses that they tell you to claim. For instance, as of January 26, 2013, a one-person household filing bankruptcy in Cuyahoga County is required to put down that they pay $301 per month for food, $30 for housekeeping and other household expenses, $86 per month for clothing, $32 per month for personal grooming, and $116 per month for other miscellaneous expenses. The reason why the law requires this is that the courts got sick of people exaggerating their expenses to make it look like they were too poor to pay their debts even though they had enough money coming in the door to pay off at least some of them. Fortunately, there are certain portions of the means test where you are allowed to put in your actual expenses and not required to use standard figures. These portions include any mortgage expense you might have, any out-of-pocket healthcare costs incurred in the six-month period leading up to bankruptcy, alimony and child support payments, one car payment per person filing bankruptcy, any taxes withheld from your wages, out of pocket costs for term life insurance, health insurance costs, and other costs.
If the means test isn't filled out right, it will trigger either a motion to dismiss or an objection to discharge from the United States Trustee, a government agency that is part of the Department of Justice. The UST is basically the bankruptcy police, and they may haul you in for tape recorded interviews concerning how you arrived at the figures you put down on the means test form. Assuming they still believe that the form was filled out incorrectly, the UST will take you to court and attempt to persuade the judge to kick your case out of court. If the UST suspects any deliberate attempt to fudge the figures, they will probably ask for an order from the judge saying that you will never, ever be able to file bankruptcy on these debts again, no matter how bad your financial situation becomes. Needless to say, if you go into one of these hearings without an experienced bankruptcy attorney at your side then you are in way, way over your head and likely to regret filing bankruptcy in the first place.
Keep in mind that the means test is only one of two tests that you need to pass in order to get your Chapter 7 bankruptcy to go through. The other test is called "bankruptcy abuse" and the problem with it is that it is quite vague. Basically-- and this is only my opinion, but a lot of other bankruptcy attorneys agree with me-- the judge looks at your whole financial situation and just goes with his or her gut feeling. If he or she feels that it would be cruel to make you pay off these debts, then you pass the test and you're good. However, if the judge looks at your situation and says, "This just ain't right," then your case gets dismissed and you don't get your bankruptcy discharge. I am oversimplifying here because there are a few standards within the bankruptcy abuse test that are very clear-- such as you cannot be cash flow positive by more than $150 or so per month and you cannot count your mortgage as an expense if you are not actually paying it-- but for the most part this test really does consist of gut feeling. For instance, should you be able to get your bankruptcy discharge even though you're sending your child to a private school that costs $800 per month? When questions like these present themselves, it is important to have an experienced advocate in your corner to prove that you are doing the best you can, that your expenses are all reasonable, and it would be an injustice to block your bankruptcy from going through.
Common Mistake #3: Paying debts you owe to friends or family members in the year prior to bankruptcy
When you pay off some people but not others prior to filing bankruptcy, the court doesn't like it. It isn't illegal, per se, but it is favoritism and not fair to the creditors who didn't get paid. What that means is that the bankruptcy court is likely to order whoever it was who received the money to give it back to the bankruptcy court so that it can be distributed between all of your creditors according to certain rules. Usually this sort of thing doesn't really bother people because they just want their bankruptcy discharge and don't care what happens to money they paid to some credit card company just before filing bankruptcy. However, when you pay money you owed to friends or family members, the story is quite different. For instance, if you pay your grandmother money that you owe her and then six months later file bankruptcy, grandma is then going to get a nasty letter in the mail saying to hand over the money or your creditors are going to sue her. This isn't the type of letter most people want their grandma to be getting.
Common Mistake #4: Missing out on an opportunity to strip judgment liens off of your home
When you file bankruptcy it is often the case that creditors have already filed successful lawsuits against you and then used those lawsuits to attach what is known as judgment liens to your home. Judgment liens are just like mortgages and eat into your home equity with one important difference: Judgment liens can be stripped off in bankruptcy. However, stripping judgment liens requires the filing of a special motion and a special hearing in front of the bankruptcy judge with full notice to creditors. I have seen many, many cases in which attorneys did not notify their clients of judgment liens on their home or did notify them but never actually got around to filing the motion to strip the lien. After 120 days the bankruptcy case closed at which point it became much more expensive
and difficult, if not impossible, to strip the liens off the home.
In most cases, the client was not aware of their attorney’s error and only learned that the judgment liens were still there when they went to sell their home but could not due to unsatisfied liens.
If you have lawsuits against you and own a home, it is imperative to verify whether there are any judgment liens on your home and whether they can be stripped off. If it doesn’t happen then you are potentially going to impair the only thing that many people have to leave to their children, which is the value of their home.
Common Mistake #5: Other common errors you are likely to regret
These errors don't fit conveniently into any one category, but I see them happen over and over again and they're worth mentioning:
A. Filing two Chapter 7 bankruptcies within an 8-year period, or filing a Chapter 7 bankruptcy within 6 years of filing a successful Chapter 13 bankruptcy
(for rules about multiple bankruptcy filings, read "Can I File Bankruptcy Again?")
You're not allowed to file bankruptcy an unlimited amount of times. You can file Chapter 7 only once every 8 years, although if you filed an unsuccessful Chapter 7 in the past then that is not counted against you. Furthermore, if you filed a Chapter 13 bankruptcy in the past and it was successful, you usually must wait 6 years before filing a Chapter 7. If you are prohibited from filing a Chapter 7 by either of these rules, you may be able to file a Chapter 13 bankruptcy, although many people do not have enough income to qualify for Chapter 13 or do not qualify for other reasons. It is very possible that you might not qualify for either type of bankruptcy, and will have to find some other option, such as a "debt workout"-- a negotiated agreement with your creditors.
B. Mixing bankruptcy and divorce without understanding that the two sometimes don't go well together
If you are currently getting divorced or recently finalized your divorce, be aware that filing bankruptcy could wreak havoc on your divorce proceedings. Usually this is not an issue if there is no valuable property involved in the divorce, but if there is valuable property then the bankruptcy court is going to look very carefully at that to make sure there is nothing fishy going on. Specifically, what the court is concerned about is that sometimes, when people know they are going to end up filing bankruptcy anyway, they become very generous in divorce proceedings and allow their spouse to have valuable property that normally there would have been a big fight over. For instance, I once saw a case in which a husband just gave his soon-to-be ex-wife his paid-off house because he was overwhelmed by debt and he knew his creditors were eventually just going to take the house anyway. By letting his wife take the house, he thought he was protecting it from creditors and giving his children a permanent roof over their heads.
Wrong. When the man filed bankruptcy, his creditors learned of his generosity and filed an action for what is called "fraudulent transfer" against him. In other words, the creditors claimed that the man would normally have fought to keep at least some of the equity in his home, and only let his wife have it in order to prevent his creditors from getting anything. The end result, after what had to have been tens of thousands of dollars in attorney's fees, was that the bankruptcy court ordered the wife to sign the house back over into the husband's name. The house was sold and the proceeds were distributed to the husband's creditors through the bankruptcy court.
C. Not being able to account for lump sums of money that you had in your control within the year or two prior to filing bankruptcy
Perhaps the ugliest scene I have ever witnessed in bankruptcy court occurred when an older woman came in to testify about her case. Her taxes showed she had cashed out her retirement to the tune of $150,000 about a year before filing bankruptcy. The bankruptcy trustee asked her some questions, became suspicious, then demanded to know what had happened to the money. The woman's attorney obviously had not prepared her for this line of questioning and all the woman could seem to do was continue to claim that the $150,000 had been put towards "bills." When the trustee asked what bills, she said gas, electric, and other run-of-the-mill bills that certainly could not have consumed $150,000 in a less-than-one-year period. It did not help that this woman was visibly drunk at the bankruptcy hearing. The trustee and the woman went back and forth until they were screaming at each other and the woman called him a dirty name, at which point he kicked her out of the hearing. I never heard what happened to the case but I highly doubt the woman got her bankruptcy discharge.
When you have a large sum of money from a retirement account, personal injury lawsuit, inheritance or life insurance settlement, large tax refund, etc., and then a few months or a year later you have none of it, you had better have a good explanation of what exactly became of that money. Ideally your explanation should include receipts, bank statements, or other documentation showing that what you say is true. If you cannot explain what happened to the money the court is likely to think that you have "mattress money" you are hiding from the court or, just as bad, that you gave the money away or wasted it on drinking, drugs or gambling. If the court concludes this was indeed what happened to the funds, not only will you not get your bankruptcy discharge in the current case but it is likely that the court will permanently deny you the right to use the bankruptcy process to discharge your debt in any future proceedings.