Six Rotten Excuses Not To File Bankruptcy

I am not a bankruptcy attorney. I never have been.  I am a mortgage law attorney.

But in the current financial climate, I see clients in my office daily who desperately need to file bankruptcy…And they won’t.

The reasons they give, and the parade of horrors they’ve built up in their minds about bankruptcy, are heart-felt, but wrong.

I’ve listed the six misconceptions below in the rough order of the frequency with which  I hear them.

Consider this my humble attempt to obliterate those “…nattering nabobs of negativism.” as Vice President Spiro Agnew once put it.

Bankruptcy Turns My Credit into Poo for Ten Years

Nope. Not so.

It will indeed be on your credit report for up to 10 years. Some say it is there forever because bankruptcies are public records that are not expunged over time if you know how to look them up.

But if you mean your credit rating? You mean that three digit number thing you’re obsessed with now, that you never even used to look at?

Plan on it returning to the 725-750 range after about two years if you’re busy paying your bills on time post-bankruptcy.

Think about it. Your score can’t get much lower after you file, and every bill you pay on time makes it go up. Your credit rating plotted over time looks more like a fetal heartbeat than a gut wrenching roller coaster ride.

No. It just ain’t so.

A Bankruptcy Will Strip Me Naked

I love this one. Bankruptcy is an incredibly powerful debt management and restructuring tool. Just ask WAMU, Lehman Brothers, Worldcom, General Motors, Enron and PG&E to name just a very, very few.

There are several types of bankruptcy filings. Each is a different highly specialized type of tool to be used to achieve very unique purposes.

Corporations use bankruptcy very strategically. The sharpest corporations know exactly to the day when they will file and to the day when they will emerge from bankruptcy. They emerge with the appetite of a hibernating Grizzly bear that slept late into summer.

The mistake most consumers make is that they rush into bankruptcy in great haste after pulling a phone number out of the yellow pages. This alone is huge mistake and often results in the consumers’ downfall.

Consumers need to consult with, and plan their filings the same way GM and PG& E did. A well timed and well considered bankruptcy can produce astonishing results for individuals.

Step one is to avoid “F&F” bankruptcy attorney. (The ones who File and Forget.) Consumers need to seek out skilled bankruptcy attorneys who are well versed in what each type of bankruptcy can do for the individual consumer and when.

Please don’t dig up the cheapest bankruptcy attorney you can find when there are hundreds of thousands of dollars riding on the outcome. The results of picking the low price leader are uniformly bad.

And the cost to fix the situation is far higher than getting it right the first time.  Some screwups just can’t be fixed.

I’ll Lose My Home if I File Bankruptcy

Nope. Not necessarily so.

Someone likely to lose their home in bankruptcy is probably equally likely lose it without filing. It just may take longer for the house to ripen into full blown economic gangrene that rots and falls off your economic body.

Currently tens of millions of homes are so far underwater that in a Chapter 7 filing, the debtor commonly keeps the house as long as they continue to make the mortgage payment. But they can often get rid of mountains of other debts.

Meanwhile in Chapter 13 debtors can strip off no-equity junior mortgages and encumbrances on the house and permanently discharge them for pennies on the dollar.

In a Chapter 11 debtors may be able to cram down their rental property mortgages to the current fair market value of the property, AND KEEP their no equity home in the bargain.

The United States Government and the lending industry actually caused the massive underwater mortgage problem. Their policies are causing the problem to get worse.

There is no reason debtors shouldn’t make lemonade from the lemons the government and the lending industry are busy growing.

I Owe Income Taxes So Bankruptcy Is Useless

I hate it when I hear this. Bankruptcy is one of the only ways to permanently get rid of income taxes.

We’re living in an era when the IRS, in the Bay Area, will not settle your tax debt unless you are unemployed, on kidney dialysis, and on a heart-lung machine.

Income taxes are dischargeable in bankruptcy if they meet the tests under the Three Year Rule, The Two Year Rule, and the 240 Day Rule. Three special time periods have to run out.

There are complex rules for figuring out if they have run, and certain things the taxpayer may have done can keep these time periods from running out.

“F&F” attorneys don’t have a clue about any of this. That’s why you need a specialist who knows what they CAN do in bankruptcy, how to do it and most importantly when. By the way, the same rules apply to the California Franchise Tax Board as well.

The corollary is that I Owe California Sale Taxes So Bankruptcy Is Useless

See the misconception immediately above. Not true.

The identical general set of discharge-ability rules applies to liability for California sales taxes. The State Board has admitted this in writing while commenting on a proposed piece of legislation. (Oops…)

See Staff Legislative Analysis 2008 for a proposed bill that would stop the accrual of interest on unpaid sales and use taxes for a small business during the pendency of a Chapter 7 Bankruptcy proceeding. Proposed Section 6593.7 for of the Revenue and Taxation Code.)

With My Income, I Will be Forced to File a Chapter 13 and Pay All the Debt in Full

Please see a solid bankruptcy specialist before concluding this is true.

It is true that there is now a Means Test for deciding whether or not Chapter 7 is available.

But it takes a damn good bankruptcy specialist to model what will happen. Depending on what you want to achieve, a Chapter 13 might actually be preferable.

Many Chapter 13 plans pay little or nothing to unsecured creditors.  It may be termed a repayment plan, but that doesn’t mean creditors necessarily get anything.

I Owe Too Much to File Any Bankruptcy

Nope. That’s like being too good looking.

It is not how much you owe. Just ask General Motors.

It is how much money and or property you have that is not subject to any debts. Where you have lots of money or other property which can be liquidated to pay your debts, filing bankruptcy may not be useful because you end up paying all the debts in bankruptcy or most of them.

It’s not the amount of debt. (except in Chapter 13.) There is NO debt limit in Chapter 7 and none in a Chapter 11 proceeding.

Wise up by shedding these bankruptcy bloopers.  Good legal advice from an experienced bankruptcy lawyer may set you free.   

More from the Soapbox

Questions for a Bankruptcy Lawyer 

Means Test in Northern California

How exemptions work

Bill Purdy is a tax and mortgage law attorney in Soquel, California helping homeowners statewide with foreclosure and loan modification issues and the taxes that may follow.  He’s written here recently on Foreclosures & 1099’s  and Four Don’ts When You’re Behind on Your Mortgage.    

Images courtesy of Leo Reynolds  and Stephen.