What is the Downside of Filing for Bankruptcy?

Like any complicated financial decision, filing a petition for bankruptcy comes with pros and cons.

The advantages of a bankruptcy depend on the chapter under which the person is filing. Some of the advantages are the total discharge of debts or the reorganization of those debts into a manageable payment plan.

If the advantages outweigh the disadvantages, then filing for bankruptcy relief may be the right choice for you. The purpose of this article is to highlight some of the main disadvantages of bankruptcy so that the reader can make a more informed decision.

What is bankruptcy?

Bankruptcy is a court-supervised process in which a person or entity (called a “debtor”) asks the court for help with their debts. Sometimes that help results in the end of those debts (known as a “discharge”) and sometimes that help is in the form of a payment plan over time. 

There are several different types of bankruptcy cases but most fall into three categories: Chapter 7, Chapter 11, and Chapter 13. 

• Chapter 7: The debtor is usually an individual or married couple and the objective is a swift and orderly proceeding to obtain an order of discharge, while maximizing the amount of property that the debtor(s) can keep. A Chapter 7 case usually takes about 120 days. 
• Chapter 13: The debtor(s) propose a payment plan to pay back their creditors at a percentage of what is owed.  Some debts are paid at 100% but most debts will receive a smaller percentage. The debtor keeps all of his or her assets in a Chapter 13 but the creditors must receive through the plan at least as much as they would have received if the debtor(s) had filed a Chapter 7. This makes the use of exemptions very important: the less non-exempt property the debtor has in a Chapter 13, the lower their payment might become. A Chapter 13 case can take as long as 60 months.
• Chapter 11: This is usually a corporate reorganization that is tailored to the needs of the debtor business or individual. Some individuals will file a Chapter 11 if they cannot meet the income requirements of a Chapter 7 and have more debt than permitted in a Chapter 13.

How does bankruptcy happen?

Bankruptcy is often considered where a debtor is having difficulty servicing all of her debt.

Perhaps the debtor is behind in mortgage payments and is being threatened with foreclosure or perhaps (s)he is behind in car loan payments and is being threatened with repossession.

Sometimes a debtor has been sued by a lender such as a credit card company and, if the plaintiff is successful, the debtor is concerned about the creditor garnishing the debtor’s take-home wages.

These are just some of the many circumstances that can lead a debtor to consider seriously the options for relief afforded by the Bankruptcy Court.

Who initiates the bankruptcy process?

In most cases, it is the debtor who files the bankruptcy case. In certain circumstances, creditors may file the petition and force the debtor into bankruptcy, but this is far less common.

Once the case is filed, a trustee is appointed to oversee the case. The trustee is an independent person who reviews the petition and takes any appropriate action.

The trustee stands in place of the creditors to make sure the petition is appropriate and that the creditors are receiving everything to which they are entitled.

What assets will be liquidated?

Whether the debtor is filing a Chapter 7 or Chapter 13 case (or any of the other chapters), all of the debtor’s assets must be disclosed on the bankruptcy petition. Failure to list assets is cause for denial of the debtor’s discharge and can subject the debtor to criminal prosecution.

A debtor must include assets such as cars, clothing, jewelry, real estate, financial assets such as stocks, intellectual property such as copyrights and patents, and lawsuits (or potential lawsuits) in which the debtor is a plaintiff or could be one.  

The law also provides a means by which property can be “exempt” in a bankruptcy case. This means that in a Chapter 7 case, these assets are not available for liquidation by the trustee.

Even though there is no liquidation in a Chapter 13 case, the exemptions are still very important because they reduce the value of the non-exempt property and can thereby reduce the amount of the monthly payments to be made by the debtor.

Exemptions are not automatic and are subject to objection by the trustee and the creditors, so having an experienced bankruptcy lawyer on your side is very valuable.

The pros and cons of filing for bankruptcy

The Pros:

Bankruptcy can be a very beneficial tool for reducing or eliminating debt and rebuilding credit. It also provides what is known as an “automatic stay” once the debtor files. This is a complete freeze on all lawsuits and collection efforts against the debtor.

Certain actions are exempt from the stay such as criminal and domestic proceedings, but generally speaking, if a debtor is being sued by a creditor, filing a bankruptcy will stop that lawsuit. However, nothing good comes without a consequence.

The Cons:

With a Chapter 7 case, unless you are very careful, you run the risk of having to turn over some of your property to the trustee to be liquidated to pay your creditors. Working with a skilled bankruptcy lawyer is essential here because mistakes made here can cost a debtor their home, their car, or other property.

Worst of all, there is no voluntary dismissal in Chapter 7; once you file, you cannot terminate your petition.

Another downside is that your credit rating will suffer as a result of filing. Of course, if you’re considering bankruptcy, the likelihood is that your credit rating is not excellent.

In many cases, though, credit will rebound to good or excellent ratings in a few years. Also, a bankruptcy will remain on a debtor’s credit report for up to 10 years and this may make it more difficult for a debtor to obtain a mortgage, auto loan, or credit card at a favorable interest rate for years to come. 

For these reasons and so many others, it’s always beneficial to consult with an experienced bankruptcy attorney before taking any action.

Is bankruptcy right for me?

Bankruptcy can be a very useful tool in the right hands and in the right circumstances. The only way to know if it’s truly right for you is to discuss the facts of your particular case with an experienced bankruptcy attorney.

The bankruptcy counsel at Cage and Miles can help you do exactly that. If you are having trouble servicing your debt, if you’re struggling to fight off a foreclosure or a repossession or a wage garnishment, or if you’re being sued by a creditor, make the call today.