Why bankruptcy of the rich and famous is nothing like yours


Why bankruptcy of the rich and famous is nothing like yours
Why bankruptcy of the rich and famous is nothing like yours

The classic image of bankruptcy is a destitute man with his pockets turned inside out. He has nothing; not a cent to his name. That's not far from reality for the average bankrupt American, yet bears little resemblance to the ultrarich (and occasionally famous) who file. Even when deep in arrears, they tend to remain flush. Worrying over the cost of bread and milk is far removed from their insolvency experience.

So how do the Donald Trumps and 50 Cents stay wealthy pre- and post- bankruptcy while us regular folks who file don't? To start, they -- or their accountants and attorneys -- turn to the right chapter.

For the rich, being bankrupt is not being broke
The word "broke" to the average American usually indicates empty bank accounts and refrigerators. However, for someone accustomed to the finer things in life, it's more of a crimp in their spending style. They've made bad business decisions, lost revenue and can't pay some bills.

So, where does a well-to-do person in a pinch turn when he has a lot of stuff to protect? Chapter 11. This little-used bankruptcy proceeding, which accounted for a mere 7,234 of 936,795 filings in the U.S. last year, is typically reserved for companies in financial distress. However, very high net worth individuals (who are often corporations unto themselves) can also take advantage of a Chapter 11 debt repayment plan. Both expensive and litigation-heavy, the process allows the affluent an opportunity to sell some of their assets to satisfy certain creditors, arrange a payment schedule for others and discharge the remainder.

"Chapter 11 is a financial reorganization for people like 50 Cent," says Eric Klein, a bankruptcy lawyer practicing in the high rent district of Boca Raton, Florida. The rap star (born Curtis Jackson) was worth an estimated $140 million in 2014, but filed for bankruptcy this year. "He has an $18 million home and is under contract to pay the big mortgage," says Klein, explaining that people are placed on a repayment plan where secured creditors get paid first, and the rest fall in line according to priority.

True, there is often is a liquidation of assets, which translates into downsizing, but once the schedule is in place the person's standard of living can rebound.

It's all relative. A rapper making $25 million with an entourage and drinking Cristal is feeling the pressure, too.

-- Eric Klein
Bankruptcy lawyer

This is not to imply that people who file any kind of bankruptcy, even Chapter 11, don't feel pain, stresses Klein. "It's all relative. A rapper making $25 million with an entourage and drinking Cristal is feeling the pressure, too."

But let's face it: Millionaires and moguls don't live hand-to-mouth before filing nor will most afterward. As staff writer for The New Yorker Jill Lepore noted in "IOU: How we used to treat debtors," an essay on the history of bankruptcy, it always has been "better to be rich and owe a fortune than to be poor and owe a pittance."

For 'normal people,' bankruptcy means broke
By far the most common type of bankruptcy used is Chapter 7, at around 66 percent of all filings. With it, individuals can escape credit card debt, medical bills and other unsecured balances. To qualify, however, they must earn less than the average income of similar households in their state or pass a test proving they truly cannot pay their creditors.

Therefore, serious hardship is the norm. Chapter 7 filers often struggle to survive. In fact, a 2015 study on "Insolvency after the 2005 Bankruptcy Reform," conducted by The Federal Reserve Bank of New York, found that a large percentage of people who pursue Chapter 7 can't afford the filing fee of a few hundred dollars, a situation that has led to "a sizable rise in insolvency and foreclosure."

The typical Chapter 7 client, according to Leon Bayer, a partner in the Los Angeles firm Bayer, Wishman & Leotta and a certified bankruptcy specialist for 35 years, is a single mother with about $30,000 in consumer debt. She receives no child support, has a low wage job and no assets to forfeit. The primary advantage for her is stopping eviction and collection action.

The next most common, says Bayer, is the young adult "without children, who has big credit card balances and over $100,000 in student loans. A paycheck won't cover it all." By discharging the consumer debt, they can manage the nondischargeable student loans that remain.

Which pretty much sums up Rachel Kramer Bussel's situation. Bussel is a writer living outside Atlantic City, New Jersey, who filed for Chapter 7 in her early 20s while enrolled in law school. "It wasn't recreational shopping -- I struggled," says Bussel. "In about three years, I got into a lot of debt. and it multiplied. I started to miss payments." She attempted a credit counseling agency's repayment plan, but still wasn't making enough to cover her obligations and so turned to Chapter 7.

The benefit for people like Bussel is freeing up funds so basic expenses can be covered. "They now have a little extra cash and that is a big relief," says Bayer.

Of course, not every noncelebrity is destitute. Some fall in the middle and that's where Chapter 13, a trustee-supervised repayment plan lasting up to five years, comes in. Unsecured debt must be less than $336,900 and secured debts less than $1,010,650. Some obligations, such as back taxes and past-due mortgage payments are repaid in full, while unsecured liabilities may be partially or completely discharged. In exchange, filers can keep their property, including homes, cars, and jewelry.

Still, the majority of Chapter 13 filers do experience great financial stress. The quintessential person who uses it, says Bayer, "has been out of work for a time, so got behind. But now he has a good job and can afford to make the house payments, but not enough for all the debt." The filer is required to pledge all extra income to his creditors, which might mean having to scale back spending. Although the Chapter 13 filer may not have to choose the cheapest peanut butter on the shelf, extravagances are not permitted.

If there's a flaw, it's that they don't face as many financial consequences. They should because they have the means. But they're smart. They know that it exists and they have equal freedom to use it.

-- Rachel Bussel
Freelance writer

That's what happened to Adam Davis, a social media expert from Alabama. Davis filed Chapter 13 bankruptcy in 2007. "I had been laid off work, accrued a ton of debt and was not able to meet my obligations," he says. He can't recall exactly how much he repaid, but certainly remembers that it kept his house out of foreclosure. "We're OK now, but it will always be tight. It's still tough, but we have to save, or we'd be looking at a worse scenario."

Post bankruptcy reality: The rich stay rich or get richer
Despite the type of bankruptcy used (and the hardships the person may or may not have suffered throughout), there are two extremely important differences between the very wealthy who file and the masses: future earning potential and current contacts. 

"Big names all have their network who will support them," says Klein. "They will come back. They have the talent, and they didn't lose that in the bankruptcy."

For this reason, an in-demand celebrity who made buckets of money the first time around is likely to do it again. After all, they've got the same skills and contacts they've always had. Rebuilding may not be easy or immediate, but most of the time it does happen eventually.

For example, presidential candidate Donald Trump filed for Chapter 11 bankruptcy four times. Not only did he never go hungry (at least not as a result of the bankruptcy), but today is a billionaire. Why? He remained "The Donald," and the same people who did business with him before often continue to do so.

Compare that situation to a disabled veteran, schoolteacher or cashier. When they file for bankruptcy, their skills, education, friends, neighborhood, co-workers and everything else usually remains constant. Casting off the chains of debts can be liberating, but it doesn't change personality, background, social standing and earning potential.

All bankruptcies provide potential for a fresh start
Despite personal limitations and social inequities, every type of bankruptcy provides debtors with a chance to reboot. Filers are required to obtain personal finance counseling and education. For Davis, that instruction was instrumental to his turnaround, as he learned self-discipline and self-control. "You don't have to have the new cars and houses," Davis says, "Have contentment with what you have. We learned it the terribly hard way."

And while all bankruptcies damage a person's credit (Chapter 13 remains on a credit history for seven years, and both Chapters 7 and 11 are listed for 10), it doesn't take long to bounce back. At first, Bussel had trouble renting an apartment with the notation on her credit report, but says she soon adapted, then moved on and up. "I assumed I would not be able to get any credit, but not true! Within two years, I got a small-limit credit card."

As for lifestyle and opportunity disparities among the variety of bankruptcy filers, Bussel feels no resentment. "They're using the same system," she says. "If there's a flaw, it's that they don't face as many financial consequences. They should because they have the means. But they're smart. They know that it exists and they have equal freedom to use it."

See related: Your map through Chapter 7 and 13 bankruptcy, Study: Law creates many too broke to file for bankruptcy

Published: September 28, 2015

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Updated: 10-26-2016

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