The decision to file for bankruptcy is a tough one no matter how you cut it.
Going through the bankruptcy process takes time and money. Once a petition is filed, a person’s entire financial situation is a matter of public record and open to others. The process will take an emotional toll on the filer and his/her family and loved ones as well.
So – again – the decision to file for bankruptcy is a tough one. One that should not be taken lightly and without considerable reflection, consideration of all the variables involved, and forethought.
This article will briefly explore some of the varied reasons why filing for bankruptcy might be the right move for financially stressed and strapped individuals. The “reasons” cited in this article are not fully determinative or all-inclusive.
As with any legal matter, people who are considering filing for bankruptcy – Chapter 7, Chapter 13, or Chapter 11 – should consider consulting with qualified legal professionals before making a final determination as to whether or not filing for bankruptcy is the right choice.
Before exploring some of the reasons “why bankruptcy may be right for you”, it will be instructive to look at a number of underlying factors and situations that might form the bases for filing under one of the bankruptcy chapters available to individuals. Those are, in brief:
Out-of-Control Medical Debt
One of the leading underlying reasons that people file for bankruptcy are exorbitant medical debts caused by chronic or catastrophic medical issues. Some of the “hidden costs” in this situation are lost income, travel expenses associated with treatment, medical equipment and in-home care costs, and other associated costs.
Medical debt, and the other negative factors associated with it such as collectors for healthcare providers, and the accompanying stress, are one of the leading causes of working people filing for bankruptcy.
Losing a Lawsuit
No matter the nature or amount of a lawsuit, losing in a court of law, with the impending negative effects of being on the losing side, such as facing garnishment, property and bank account attachments, and loss of assets, is another driver of bankruptcy filings.
Foreclosure on a Primary Residence
For many, a pending foreclosure that a debtor has not been able to settle with the lender is another factor that causes people to file for bankruptcy. Under a Chapter 13 repayment plan, debtors can usually save their home and stop the foreclosure. The automatic stay provisions in bankruptcy allow the debtor to effectively have the time to catch up on loan payments.
Debt Repayment Post-Divorce
In many cases, a divorce will leave one spouse saddled with a disproportionate level of former community debt. In Chapter 7 cases, much or all of such debt can be liquidated; in Chapter 13 cases, a realistic repayment plan can be devised and agreed upon by the debtor and creditors.
Loss of Employment – Drastically Reduced Income
When someone loses his/her employment, or when a family’s take-home pay has been radically reduced, the bills and debt obligations continue – and – after a short while, the collection calls begin. When the mortgage is due, or when the car payment is coming up soon, the stress of trying to juggle everything while still looking for work can become overwhelming. In such a case, a Chapter 13 filing with a reasonable plan to help manage debts and work one’s way out of debt is probably something a prudent person might consider.
Debt from Small Business Enterprise
Owning a small business is something akin to “walking a tightrope without a net” when it comes to managing finances, debt, and inventory. A small business that is having a hard time keeping up with regular loan payments, “brick and mortar” rent, and other expenses, is basically “bankrupt” already. Declaring bankruptcy (in this case, Chapter 11 bankruptcy) allows the business to stay open and engaged in its usual business – the business continues to earn money while in the bankruptcy process, which includes a reorganization plan, consolidation of debt, and the negotiation of better terms on the owed debt.
Debt from a Failed Business
Sometimes, start up companies or other attempts to make a “going concern” out of a business fail, resulting in a lot of debt. A lack of income from the expected return from the operations of a business is an exacerbating factor for the debtors in this scenario. There are specific, special rules permitting those in this situation to qualify for a Chapter 7 liquidation filing or a Chapter 13 reorganization filing.
When faced with an aggressive, “take-no-prisoners” creditor, debtors are often subjected to having a lien placed on their property or with a wage garnishment order. Debtors can buy some time (again, the bankruptcy automatic stay provisions) to get their finances in order by filing for bankruptcy. As a cautionary note, debtors should make every effort to file for an inevitable bankruptcy before a creditor takes them to court – once a judgment is in place, it is harder to get a handle on a personal financial situation.
Student Loan Debt
As a general premise, student loan debt (except in a narrow set of circumstances) is not dischargeable in Chapter 7 bankruptcy. For the younger generations, excessive student loan debt is the #1 problem that they face financially. Being unable to discharge such debt in Chapter 7 doesn’t mean that those debtors are out of luck. A Chapter 13 filing is available to help them plan for and manage their student loan debt.
Consumer Credit Debt
Credit card debt is a common issue these days for a majority of Americans. It can be damaging to a person’s personal finances, as well as to his/her credit score. For debtors who only make minimum payments on such debts, interest and late charges quickly increase the total amount owed in the first place. In today’s society, many consumers with a large amount of consumer credit debt try to file for Chapter 7 bankruptcy (and, some are driven in to Chapter 13 because of a failure to qualify for Chapter 7).
The TOP Five Reasons to File for Bankruptcy
Number One: With several noted exceptions, under any Chapter of the Bankruptcy Code (Chapters 7, 13, and 11 included) the automatic stay provision is of great benefit for a debtor. This provision immediately halts all ongoing legal and collection efforts against the debtor. A stay is automatic and immediate with the filing of a bankruptcy petition. The effect of the automatic stay is to cease, immediately, any and all collection calls, lawsuits, foreclosures, and wage garnishments.
A debtor facing foreclosure on a residence may be able to catch up on mortgage arrearages and obtain a loan modification. The same may apply to a business property. In Chapter 11 and 13 filings, the automatic stay provision can be critical in a debtor taking the necessary steps to stop a foreclosure and plan to modify the underlying loan with better terms.
Number Two: Debtors who file for bankruptcy are seeking a “fresh start” with finances. The #2 reason to file for bankruptcy is to regain full control of a debtor’s finances.
Individuals can get a “fresh start” through the filing of bankruptcy under Chapters 7, 13, and 11 of the Bankruptcy Code. Under Chapter 7, a qualified debtor can obtain a “fresh start” by liquidating most debts that will allow the debtor to “wipe clean” the financial status upon final discharge. Fairly recent bankruptcy reforms now require a Chapter 7 debtor to pass a “means test” before qualifying to file. Those reforms also imposed the requirement of financial counseling both pre and post-filing. Debtors who do not pass the means test or otherwise qualify may still avail themselves of filing under Chapter 13.
Under Chapters 13 and 11, the debtor’s financial slate is not “wiped clean” as under Chapter 7. Instead, debtors are required to develop a repayment plan for many debts and pay “according to their means” over a period of some 3 – 5 years (per terms of the plan sanctioned by the Bankruptcy Court / Trustee). At the end of the agreed upon period, remaining debt under the plan can be discharged (i.e. liquidated) at the close of the case.
Number Three: Under the Bankruptcy Code, certain property is considered exempt from the claims of creditors in Chapter 7 proceedings. (State law governs what property is considered exempt in such proceedings – debtors should be aware of what exemptions are available in their state of residence)
The #3 reason for choosing to file for bankruptcy is that even if a debtor seeks and obtains a discharge of his/her debt – obtaining a “fresh start” under Chapter 7 – the law allows the debtor to retain certain “essential property” as “exempt” and protected from the claims of creditors. Such exemptions usually apply to:
- A personal residence / home
- A personal vehicle
- Household goods
- Retirement savings
A debtor may also choose to obtain protection from creditors and the ability to keep certain essential and “non-exempt” property by choosing to file under Chapter 13 or Chapter 11. In this scenario, property that might be sold or liquidated under Chapter 7, is included in a reorganization/repayment plan in Chapter 13 or 11 proceedings – such a plan would provide for the payment to creditors an amount that is not less than the creditor would have received in a Chapter 7 case. In Chapter 7, non-exempt property is sold with the proceeds paid to creditors; in Chapter 13, non-exempt property can be kept if the debtor adheres to the terms of the repayment terms over a period of from 3 to 5 years.
Chapter 11 proceedings can work in a similar way for high-income and high-debt individuals and by businesses to reorganize while continuing the business during the proceedings.
Number Four: The #4 reason a financially strapped debtor might choose to file for bankruptcy is the effect that judicial liens have on property.
A judicial lien results from a lawsuit in which the debtor has been found liable for a debt that affects the debtor’s property – a home for instance. In bankruptcy, judicial liens that impede and impair exemptions can be “stripped off” of real estate or personal property with the property being retained free of encumbering liens.
Alternatively, property can be sold free of liens or other encumbrances which allows the debtor to preserve protections offered by state or federal exemption statutes (including the homestead exemption and some personal property exemptions).
In today’s real estate market, there are many instances where a home’s market value is less than what is owed to a mortgage company (the debtor is “underwater” on the loan). The same is true where a judicial lien has been attached to real estate (which is being “underwater” by reason of a judicial lien). Filing for bankruptcy allows an “underwater” debtor to take advantage of homestead exemptions and other state or federal exemptions.
As one article pointed out:
Filing for bankruptcy is a way to control the sale of real estate and protect
what homestead rights the debtor has in a primary residence at the time of
filing, free from liens, claims and encumbrances of creditors. Any claims
would be paid from non-exempt proceeds of the sale… The Bankruptcy
Code provides the debtor with the right to sell property in a manner and at
a time which will guarantee the highest value… (emphasis added)
Number Five: A debtor with certain types of obligations (for instance, tax liabilities or family support obligations) may be inclined to opt to file under Chapter 13 or Chapter 11. Under those chapters, certain obligations may be treated differently than others. A debtor may be able to obtain a discharge of most kinds of unsecured debt while repaying those obligations – under a 3 – 5 year “plan” – that are estopped from being discharged in bankruptcy.
Chapter 13 and Chapter 11 may be a wise choice for debtors who have such debts as taxes or domestic support obligations such as court-ordered child support and alimony. Such debts can be separated out as “priority claims” in a financial restructuring plan and they can be paid off over a period of time set within the plan.
A Chapter 7 filing, on the other hand, will discharge and liquidate certain debts in their entirety. But, Chapter 7 is not the chosen method to deal with unresolved tax and domestic support liabilities. When faced with debts of this nature, the debtor needs to use great care and consideration in determining under which Chapter of the Bankruptcy Code to file.
As noted at the outset, there are a plethora of reasons that financially strapped debtors may choose to file under one of the several bankruptcy chapters. The five that are noted in this article are not all-inclusive.
Anyone who is in a position of even having to consider filing a bankruptcy petition would be well-advised to consider consulting with a qualified legal professional to assess all options and get the help that may be needed to make a final determination when faced with the self-imposed question, “should I file for bankruptcy?”.
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