Common Pre-filing Mistakes to Avoid

The following are some common pre-bankruptcy mistakes to avoid. If you have made one or more of these mistakes, don’t worry – we will simply consider altering our strategy and/or timing.

1. Taking out a 401(k) or pension loan to pay credit card debts.  Falling behind on credit card payments can result in unrelenting and unpleasant phone calls from credit card bill collectors. Often, these calls can border on being abusive. You may be tempted to do anything you can to stop the calls, including taking money out of 401(k) or other retirement accounts to pay down the credit cards. This is not a good strategy because credit card debt is unsecured, which means that the credit card lender is at the bottom of the list when it comes to getting paid. They have no property to seize, and they cannot garnish your wages unless and until they obtain a judgment against you.

   In most cases, pension funds are considered “exempt” or sheltered property, which you are allowed to keep while wiping out your unsecured debts. If you invade your 401(k) or other retirement plan to get money to pay unsecured debts and you do end up filing for bankruptcy, you will find you have used exempt assets to pay off debts that would have otherwise been wiped out in your bankruptcy case. You may also find you must pay early withdrawal tax penalties if you were otherwise ineligible to withdraw funds from your retirement account.

2. Transferring credit card debt from high interest cards to low interest cards. The bankruptcy code gives credit card lenders greater protection in the case of cash advances and purchases made within 60 days of filing. A balance transfer is viewed as a cash advance, and can be challenged by the creditor after you file. If you have made a balance transfer, I may advise you to wait several months prior to filing and I may advise you to make monthly payments while you are waiting to demonstrate good faith.

3. Filing when you are expecting a large tax return. Although bankruptcy exemptions allow you to shelter some cash assets like a tax refund, you are usually better off filing your case after receiving and using your tax refund money.

4. Repaying family loans prior to filing. In difficult financial situations, people often turn to family or friends for help. If you file for bankruptcy, however, you cannot treat family and friends differently from other creditors. The Bankruptcy Code prohibits “preferential transfers” or paying some creditors more than what they would have otherwise received in the bankruptcy case. Often, a debt payment to a family member or other “insider” made within one year prior to filing is considered a preference and can be reversed by the bankruptcy trustee.

5. Transferring assets prior to filing. If you own real estate, motor vehicles, money in bank accounts, or other assets, and you transfer ownership out of your name to defeat the claims of creditors, the bankruptcy trustee can file suit in bankruptcy court to avoid the transfer.

   This situation sometimes arises when a person preparing to file for bankruptcy remembers that their elderly parent added their name to a bank account or deed to their house for estate planning or convenience reasons. Even if you have never considered it “yours,” the bankruptcy court could consider the asset to be part of your bankruptcy estate and may try to seize it. This is why it is important for us to discuss your situation and talk about all property that has your name on it or that you expect to inherit.

6. Significant credit card usage prior to filing. The bankruptcy code states that if you incur $500 or more in credit card debt to any one creditor for non-essential items within 90 days prior to filing for bankruptcy, this debt is presumed non-dischargeable. Credit card debts of any amount, incurred at any time prior to filing may be deemed non-dischargeable if the creditor can prove that the debt was incurred under false pretenses (i.e., that you used the card when you knew or should have known that you would be unable to pay back the debt).

   Keep in mind, however, that if a credit card lender files an objection in your case, you have to pay a lawyer to respond and defend it – which can get expensive. This is why I advise my clients to hold off on filing for as long as possible following their last use of credit cards. I also recommend they continue to make at least the minimum payment for several months while we are waiting to file to demonstrate their good faith.

7. Waiting until one or more judgments are obtained against you prior to filing. If you have been served with a summons and complaint, it is time to sit down with an attorney and discuss your options so you can make intelligent decisions. If you ignore the lawsuit, the plaintiff will obtain a default judgment against you. If the complaint contained allegations of fraud, intentional misconduct or other types of non-dischargeable debt, you will not be able to wipe this judgment out in bankruptcy and will have given up your chance to fight the case.

   If a lawsuit is filed against you, it is time to seek legal advice to explore all of your options, including bankruptcy and non-bankruptcy alternatives.

8. Offering post-dated checks to creditors. Bouncing a check can be a criminal offense in Michigan. Although you may instruct a collection agency to hold a check for a certain length of time, experience has shown that you cannot trust aggressive collection agencies to hold your post dated checks for any length of time, nor can you trust them not to deposit all of your post dated checks at once. Your bank will similarly deny responsibility for negotiating post-dated checks. If your post-dated checks bounce, your creditors may now threaten criminal charges against you. Obviously, this is a situation to avoid by simply refusing to send creditors any checks unless you know they can be negotiated immediately.