Worried that a bankruptcy judge or trustee is going to scour your spending before bankruptcy, looking for behavior that would disqualify you from bankruptcy relief.
It’s not so.
Yet there seems to be real anguish that “they” are going to toss your case out of bankruptcy court because of some “fault” in how you’ve handled money.
So, let’s look at the real and the invented constraints on spending before bankruptcy.
Your money is yours
Before bankruptcy, you can spend your money wisely or not-so-wisely, without real fear of negative repercussions in your case. You can spend cash lavishly, invest recklessly, or gamble it away.
You can buy clothes, replace broken appliances, pay your dentist, put on a kid’s party without comment from bankruptcy players. You can even pay down creditors that are important to you, though a trustee may claw-back those payments if they are large.
No one in the bankruptcy system gets to penalize you for “bad” money management. If we limited bankruptcy discharges to those who handle money well, the bankruptcy courts wouldn’t be nearly as useful to society.
Some transfers are no-nos
What you can’t do is give assets, cash or tangible “stuff”, away to keep it from your creditors.
That includes changing title to assets in an attempt to keep the asset “safe” from creditors. That’s a fraudulent transfer, and can be the basis of denial of discharge.
You can sell assets, so long as you get a reasonable price for the asset, given its condition and the current market.
New debt is different
It’s recent or uncharacteristic credit card use that presents possible problems.
The credit card company may challenge the discharge of those charges, claiming that your use of the card was fraudulent since you knew you couldn’t or didn’t intend to repay the debt.
The facts matter: if the near-bankruptcy charge is for gas or groceries, a nondischargeability action is highly unlikely. If it’s a cruise or redecorating your home, perhaps there’s pushback. In particular, purchase of luxury goods on credit within 90 days of filing and large cash advances within 70 days are presumed to be nondischargeable. In a bankruptcy adversary proceeding over these kinds of charges, the burden is on the debtor to prove that the purchase wasn’t fraudulent.
But it’s important to understand that inappropriate use of a credit card does not imperil your right to a discharge as to every other dischargeable debt you have. It only affects the discharge of the debt to the complaining creditor.
New secured debt is OK
Taking a loan close in time to bankruptcy is unexceptional if the lender gets collateral as part of the loan. Think the purchase of a vehicle. The lender gets a lien on the car you buy and that lien will survive the bankruptcy.
I frequently send prospective bankruptcy filers out to shop for a replacement vehicle before they file bankruptcy. Often, they get better rates than if they waited until after bankruptcy to replace an aging ride.
The only caution is that the loan application be scrupulously honest and complete.
Pick and choose among creditors
You hear a lot about the “90 day rule”. The rule is only of concern to your creditors; it has no impact on you. A payment made on an old debt within 90 days of filing, that totals over $600, and allows that creditor to get more from you than they would get through the bankruptcy if you hadn’t paid, is a preference.
The trustee may choose to sue the recipient of that preference to return it to the bankruptcy estate. It is not wrong for you to have made the transfer on a genuine debt. The law says simply that it’s unfair to other creditors, and claws it back to share among all creditors.
Often the amount of money involved is too small to merit the attorneys fees to recover the preference and nothing happens.
Insider preferences
The preference that does mean something to the debtor is payment of a debt to family or other closely related entities, like your corporation.
Insider preferences have a one year look back period, rather than the 90 days for unrelated recipients. There, you may care a whole lot if you paid your mother back recently and the trustee wants the money back from her.
Contemporaneous exchanges raise no issues
Another financial transaction that has no bankruptcy consequences is a purchase. You pay money and you get something in return. It doesn’t matter whether the “something” is goods or services or experiences. Money left your pocket and something of equal value was acquired.
That’s a contemporaneous transfer and it’s not a preference.
Accounting for recent windfalls
About the only time the trustee digs into where the money went is when you get a large, out-of-the-ordinary payment that isn’t still in your bank account when you file. The source of those funds could be a bonus, an insurance recovery, a large tax refund, or an inheritance.
The trustee asks about what you did with the money, not to see if he approves of your money choices, but to see if either you left a purchase out of your asset schedule or if you paid off a creditor with a preferential payment that he might recover for the benefit of all creditors.
No second guessing money management
I can’t say too often or too loudly: your bankruptcy discharge does not depend on the trustee’s subjective opinion of your spending before bankruptcy or your money management skills. Bankruptcy relief is available to the foolish, the over-optimistic, and the extravagant as well as the simply unfortunate.
The chief requirement to get a bankruptcy discharge is honest disclosure of your situation.
