Common scenarios when bankruptcy should be seriously considered
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But life doesn’t always turn out as planned. Bad things happen. The reason bankruptcy laws exist is to provide financial relief for people who cannot pay back what they owe.
Here are seven common circumstances in which filing for bankruptcy can help:
1. You have overwhelming debts from your small business.
Starting a business is always risky, and the business may fail due to market or economic downturns, partner problems or a host of other reasons. A business failure can leave enormous debts and no income to pay them with. A way out may be to file for Chapter 7 bankruptcy. Chapter 7 is the type of bankruptcy most people think of first, in which certain business or individual assets are used to pay creditors and any remaining unsecured debts may be discharged.
Bankruptcy doesn’t always mean the end of a business, however. Chapter 13 bankruptcy can help save an overextended small business by allowing the owners to restructure its debt by working with the court to come up with a plan to pay off debts over a period of three to five years.
California attorney Jen Lee, author of “Preventing Credit Card Fraud: A Complete Guide for Everyone from Merchants to Consumers,” has seen small businesses with too much business debt that the owners haven’t been able to pay or work out a solution for without protection from the bankruptcy courts.
“I had a retail establishment that was behind on everything, and the owner’s house was in foreclosure,” says Lee. “We put her into a Chapter 13 bankruptcy, where she could repay some of her debt and keep her business going. At the end of five years, she came out with her debt reorganized. She saved her house, saved her business and even saved for retirement. She did everything she was supposed to. She’s one of my favorite stories.”
2. You or a family member have a catastrophic health crisis.
Medical bills alone can force a person into bankruptcy, although it’s often not the only reason leading up to the filing.
Besides medical bills, a person who is ill may have travel and lodging expenses so they can receive care. They may have to adapt their house to special needs. Family members may take time off work to help.
According to Alabama bankruptcy lawyer David Poston, of Brock & Stout Attorneys at Law, prolonged medical issues can have an effect similar to long-term unemployment.
“If a consumer does not have short-term or long-term disability insurance, many times that person is without income to meet even the most basic monthly living expenses. The debt payments continue to increase, and quickly spiral out of control,” he says.
Lee has seen bankruptcy help those with overwhelming medical debt.
“One couple had medical debts of upward of $200,000. They had tried to negotiate with hospitals and medical providers, but they weren’t willing to take anything lower. We weren’t expecting them to have any additional medical bills,” she says.
Lee explains why that’s an important point. If you need another $100,000 in services, and you’ve just had your debts discharged through bankruptcy, the same medical providers may not serve you again unless you can afford to prepay.
3. You accumulated debt during extended unemployment.
If you’ve ever been out of work for a significant period of time, you know how the bills add up. When you eventually do go back to work, perhaps even at a lower rate of pay, it’s difficult to catch up.
“While the person may be entitled to unemployment compensation,” Poston says, “many times the benefits will be insufficient to pay debt loads. The unemployment compensation will barely pay basic housing, utilities and food.” Before long, the debt payments may become overwhelming, and the person may need some form of bankruptcy protection.
4. You are sued.
Sometimes, ordinary people are sued for extraordinary amounts – and they lose. Unless they had liability insurance, they may never be able to pay the resulting judgment.
The only way out sometimes is filing for bankruptcy. “If it’s not a case where it was fraud or fiduciary duty, those are all dischargeable in bankruptcy,” Lee says.
Lee has had clients who could not even afford to defend themselves against the suit, let alone pay the judgment. “Bankruptcy allowed them to stop the bleeding,” she says.
5. You get divorced.
Divorce can be one of the most financially devastating events in a person’s life. Sometimes existing financial problems contributed to the divorce. People fight over money when they split up, and then they have to pay lawyers.
“When a couple makes financial decisions based on two incomes, a divorce can have devastating effects. This is especially true when one spouse or the other has obligated himself or herself to [be responsible for] the majority of the debt,” Poston says.
6. You can’t repay student loan debt.
As a general rule, you can’t wipe out student loan debt by filing for Chapter 7 bankruptcy.
“Another less-common situation – I would argue, underused situation – is filing bankruptcy to address your student loan debt. Chapter 13 is great for doing that,” says student loan attorney Stanley Tate, founder of Tate Law in St. Louis.
While Chapter 13 bankruptcy is an option, it’s complicated. To have student loan debt dismissed or discharged in bankruptcy, the debtor must be able to prove undue hardship, such as a permanent disability or have a long record of on-time payments showing good faith intentions in repaying the debt before becoming unable to meet those obligations.
7. You get hit by a perfect storm of catastrophes.
Sometimes trouble comes from everywhere at once. For example, Lee had a client who was a single mom. She was threatened with wage garnishment over credit card bills. She wasn’t receiving her child support. In the middle of her troubles, her car broke down.
People may financially survive one or two calamities, but when the blows keep coming, they sometimes need to ask for help – which can come in the form of bankruptcy protection.
Video: Chapter 7 vs. Chapter 13 bankruptcy
Does bankruptcy make sense for you?
Bnkruptcy should be a last resort. It costs you time, money and ruins your credit for several years. Depending on the value of your assets and the laws of your state, you could lose your vehicle, bank accounts and possibly even your home. It also forces creditors to accept less than what you owed.
It’s important to be clear on what you want to accomplish by filing. Bankruptcy makes sense when your debts can be discharged or reorganized, and when the problem that caused you to need to file for bankruptcy is not ongoing. Bankruptcy does not cure habitual overspending, or an income that doesn’t cover your needs.
Some people avoid filing just because of the loss of financial privacy.
“Bankruptcy is life in a fishbowl,” says Robbin Itkin, a bankruptcy lawyer at Liner LLP. “I had a client very concerned about disclosing payments due to creditors his wife didn’t know about. He would not be able to bring those creditors current before filing, so would have to list them as creditors on his schedules, which are public documents.”
Helping people resolve financial matters in a private versus public matter can be beneficial to all interested parties.
‘Should I file’ rules of thumb
Bankruptcy attorneys have different rules of thumb for helping clients decide whether to file for bankruptcy.
Lee’s is that people need to consider bankruptcy if their minimum debt payments are more than mortgage or rent. “I look at their monthly budget and see if they can pay off credit cards, if it’s possible, or they’re at a point where they can’t afford the minimum payments.”
The closer you are to retirement, the more important it may be to get out of debt and save for retirement. “If they have no retirement savings, they may be better off starting over and working on retirement savings so they don’t have to live in a box in retirement,” Lee says.
Tate recommends comparing debt negotiation (in which you negotiate with your creditors to pay less than what you owe) to filing for bankruptcy. “Add up all your debt. Divide the number in half. And ask yourself how long it would take you to pay that off if you could settle your debts for that amount. Now compare that to the time and cost of filing bankruptcy. Which one do you prefer?”
If you decide you can resolve your debts some other way than through bankruptcy – great. Otherwise, don’t hesitate to take make the best decisions so you can take care of yourself and your family. As Itkin says, “If bankruptcy is determined to be the appropriate course, do not worry about negative stigma. How you conduct yourself before, during and after your bankruptcy case is what people will remember.”