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Misconceptions Regarding Bankruptcy

Posted by attorney Steven Fahlgren

I am often surprised how many misconceptions there are as far as bankruptcy is concerned. My paralegal and I have put together a list of common misconceptions regarding bankruptcy.

1. The debtor must be flat broke to file for bankruptcy. Wrong. With limited exceptions, the only requirement to file for bankruptcy is that the debtor cannot pay bills as they come due. A “debtor" is an individual or entity that owes money. Most people are debtors, but not all are bankrupt. Because individuals and businesses often wait until they are flat broke to seek bankruptcy advice, this delay limits their options, some of which may help them reorganize their finances and keep part or all of their property. For example, an individual normally waits until the day before a foreclosure sale to seek bankruptcy advice; had he sought advice earlier, his chances of losing the property would have been diminished significantly.

2. An individual who files for bankruptcy will not qualify for credit in the future. Wrong. The fact that an individual files for bankruptcy will appear on an individual’s credit report for up to 10 years. Any individual considering filing for bankruptcy probably has poor credit already. Filing for bankruptcy may be the best bet to “get good credit" again, because when a debtor files for bankruptcy under Chapter 7 of the Bankruptcy Code and receives a discharge (relieving the debtor of the obligation to repay most debts and preventing creditors from collecting for the same), the debtor cannot receive another discharge under Chapter 7 for at least six years from the date of filing the prior bankruptcy and eight years in most circumstances.

3. An individual who files for bankruptcy cannot buy a house. Wrong. Like all lending institutions, mortgage lenders are willing to take risks with a debtor as long as the lender has enough security. This generally means charging higher interest rates and requiring personal guarantees. If a person who had filed for bankruptcy in the past applies for a mortgage and can fund a sufficient down payment, most banks will approve a mortgage loan if the person otherwise qualifies.

4. A homeowner who files for bankruptcy will lose her house. Yes and no. In the state of Florida, under what is called the “homestead exemption," an individual is allowed to keep their home. Now consider an individual who is behind on her mortgage, has substantial equity in the property, and has a lot of credit card debt. In this scenario, assuming the individual has a regular source of income and, after paying her regular monthly bills (i.e., mortgage payment not including arrears, food, and utilities), any money left over can satisfy the arrearages on the mortgage over a period of not to exceed five years, the individual may be able to keep the house in Chapter 13. Although Chapter 13 is complicated, the principle is simple: As long as an individual repays the debt or at least pays what she would have paid in a Chapter 7 bankruptcy over the life of the Chapter 13 plan and otherwise pays secured creditors in full as part of the plan, she can keep the property.

5. Taxes cannot be discharged in bankruptcy. Wrong. Some taxes are usually dischargeable in bankruptcy, such as personal income taxes that are more than three years old. As a general rule, fiduciary taxes are not dischargeable. The Bankruptcy Code’s provisions relating to taxes are complex, and differ by chapter. It is important to always seek counsel relating to your specific situation.

6. Student loans are nondischargeable. This is generally true, but with exceptions. If the debtor can prove certain hardship, student loans may be dischargeable.

7. An individual can file for bankruptcy but not include certain creditors. This is not true and could be a violation of criminal law and result in your discharge being denied. One principle behind the Bankruptcy Code is to treat similarly situated creditors equally. When a debtor does not list a creditor in bankruptcy and decides to pay back that creditor, that debtor is necessarily prejudicing the other creditors. When a debtor does this, the court usually considers this fraud, and the debtor risks losing the discharge and, in extreme circumstances, may face jail time and substantial fines.

8. Family members who loaned money to the debtor will lose out. Wrong. Although a debtor must list all creditors in the bankruptcy, in certain instances the debtor can repay certain creditors after the bankruptcy is filed. This is commonly known as a reaffirmation agreement. All reaffirmations are subject to court approval. Most debtors agree to pay back a debt they have no legal obligation to pay so as to maintain an existing business relationship. The court would probably approve the reaffirmation if the debtor lives with the creditor and may be forced to leave if he does not repay the debt.

9. Signing a reaffirmation agreement stating that a debt cannot be discharged in bankruptcy makes the debt nondischargeable. Wrong. Although there are extremely limited exceptions, these bankruptcy clauses (known as ipso facto clauses) are unenforceable and are a tactic used to scare debtors into not filing bankruptcy.

10. A person can lose his job if he files for bankruptcy. Wrong. The law states that if an individual can prove that an employer fired an employee solely because the employee filed for bankruptcy, the employee can sue the employer. If the debtor/employee looks for another job after filing for bankruptcy, however, a potential employer can use the bankruptcy filing as a factor (not the sole factor) in deciding whether to employ that individual.

11. Bankruptcy will Clear All of Your Debts. While insolvency will eliminate the majority of debts that an individual may owe, there are debts that are exempt from Chapter 7 or Chapter 13 bankruptcies. Amongst these, the most common debts that an individual will still be eligible to repay are federal and specific state taxes, student loans and any debts accrued as a result of cases of fraud. There are particular caveats to instances of student loans and, as such, it is always best to consult an attorney.

Disclaimer: The above Article is intended to give you, the consumer, insight into various legal topics. This information is not intended as legal advice, but rather helpful topical information.

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