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  Disadvantages of Filing Bankruptcy -
 


     Before you decide to file is best for you and your attorney to look at all aspects of your case, including the disadvantages of a bankruptcy filing. Some of these disadvantages include the following;

  • Loss of Privacy
  • The Automatic Stay Is Limited
  • The Discharge is Limited in Scope
  • A Discharge Can Be Denied
  • Liens "Ride Through" Bankruptcy
  • Lien Stripping Has Restrictions
  • Avoiding Powers Can Be Damaging
  • Filing Can Terminate Certain Contracts
  • Can Be Time-consuming
  • Can Be Expensive
  • Negative Impact on Credit, Alerting Creditors
  • Attorney-Client Privilege May Be Lost
Loss of Privacy

     Loss of privacy results upon a bankruptcy filing. Bankruptcy cases are public records and are viewable by the public 24/7 through PACER, the Public Access to Court Electronic Records. Although the debtor's social security number is redacted when viewed by the general public the debtor's personal finances, including income, expenses, dependents, assets and liabilities, become a matter of public record. This is something that generally does not happen without a bankruptcy filing. It is part of the tradeoff involved in debt relief. To get relief from his debts, the debtor needs to be willing to give up some of his privacy rights. This is a consideration that may come into play when contemplating the bankruptcy strategy.

 

The Automatic Stay Is Limited

     The automatic stay may not even apply to the situation confronting the debtor. There are 28 exceptions to the automatic stay, found in Bankruptcy Code Section 362(b). Some examples are:

  • Criminal actions
  • Paternity suits
  • Establishing or modifying domestic support obligation orders
  • Child custody or visitation matters
  • Marital dissolution actions (except as they may relate to property division)
  • Collection of domestic support obligations
  • Tax audits
  • Actions by a lessor of nonresidential real property to evict the debtor where the lease expired by its terms before the bankruptcy filing
  • Eviction actions involving residential real property where the lessor obtained an eviction judgment before the bankruptcy case was filed
The Discharge is Limited in Scope

     The discharge is limited by which Chapter was filed:

  • Chapter 7 - Only individuals (no corporations or partnerships) can receive a discharge.
  • Chapter 11 - Individuals, as well as corporations and partnerships, can receive a discharge.
  • Chapter 13 - Only individuals can file, and they will receive a discharge.
     Certain debts cannot be discharged, including:

  • Domestic support obligations
  • Obligations under marital settlement decrees
  • Debts based on fraud, misrepresentation, breach of fiduciary duty, embezzlement, or theft
  • Those based on willful or malicious injury to another person or that person's property
  • Recent taxes
  • Educational loans
  • Drunk driving damages
  • Criminal fines and restitution awards
A Discharge Can Be Denied

     A bankruptcy discharge is meant for the "poor but honest debtor": The general rule is that an individual debtor will receive a discharge. However, there are exceptions to that rule, set forth in Bankruptcy Code Section 727(a). These are generally situations where the debtor has done something wrong which impacts his creditors as a whole, including:

  • Transferring property within one year prior to the bankruptcy case with the intent to hinder
  • Delay or defraud creditors
  • Destroying concealing, falsifying, or failing to maintain, records from which the debtor's financial condition can be determined
  • Refusing to comply with bankruptcy court orders
  • Lying in the bankruptcy papers
Liens "Ride Through" Bankruptcy

     While the discharge wipes out the debtor's personal liability for the underlying debt, it does not eliminate a lien that covers property, except in certain circumstances. Generally, once the bankruptcy case is over, the lien "rides through", and the creditor is free to enforce the lien after the bankruptcy case. This includes claims by car creditors, mortgage companies, and other secured creditors.

Lien Stripping Has Restrictions

     "Lien-stripping is not available in Chapter 7, and the secured debts simply "ride through" the bankruptcy filing. In Chapters 11 and 13, lien stripping is allowed. However, it is not allowed where the debt is secured only by a lien on property that is the debtor's principal residence.

Avoiding Powers Can Be Damaging

     If a transfer has been made in the past 90 days, or year (for insiders and relatives), to which the debtor does not object, the debtor may wish to wait until the preference or other period has expired, before filing the bankruptcy petition. Otherwise, the trustee may exercise his avoiding powers to recover the payment or other property transferred.

 

Filing Can Terminate Certain Contracts

     Many contracts, leases and other legal documents have wording in them to the effect that if one party to the contract files bankruptcy, then that is an act of default under the terms of the agreement. This permits the other party to have recourse to its legal remedies, often including termination of the agreement. This is often called an "ipso facto" clause. This can have disastrous effects on the debtor. Most such clauses are not enforceable, by express terminology in the Bankruptcy Code. They are considered to be against public policy. However, there are some instances where they are enforceable, like in the case of franchise agreements.

     Also, in most states, a bankruptcy filing by a partner of a general partnership, or by the partnership itself, results in a dissolution of the partnership, unless the other partners decide to the contrary. Thus, it is critical that the pre-bankruptcy strategy session include a comprehensive review of the debtor's contracts and other legal documents to review the impact of a filing on the debtor's legal rights.

Can Be Time-Consuming

     When considering whether to file bankruptcy, and if so, what chapter, the time demands can be an important consideration. It takes a fair amount of time to put together all of the required information and documentation for a bankruptcy filing, even more so for Chapter 11, 12 and 13 reorganization/adjustment cases. The debtor is also required to attend the meeting of creditors, and possibly also court when needed. This can force the debtor to miss work, and other important demands on his time. The debtor and attorney should discuss this prior to making the decision to file.

Can Be Expensive

     To file bankruptcy, a debtor will most likely incur attorney's fees and court costs. These can end up being quite substantial, especially in the reorganization chapters like 11 and 12. These fees and costs should be taken into account when evaluating the bankruptcy strategy. If creditors are not likely to pursue the debtor in state court, because debtor is judgment-proof and has no assets from which his debts can be paid, then maybe the debtor does not need to file bankruptcy and he can save his money.

Negative Impact on Credit

     A debtor contemplating a bankruptcy filing will want to consider the impact of the filing on his credit report. The filing is a public record and will be reported on the public records portion of the credit report for up to 10 years, under 15 U.S.C. Section 1681c(a)(1). It will be considered derogatory.

Alerting Creditors

     A debtor may owe debts to certain creditors who are not pursuing payment, because they do not want to incur the attorney's fees and costs involved. Filing bankruptcy means that these creditors will end up being dealt with. Without a bankruptcy filing, they may have just written off the debt and forsaken any attempts to collect from the debtor.

 

Attorney-Client Privilege May Be Lost

     Most states have laws which protect as privileged those communications between a client and his lawyer. In individual cases, this privilege is generally carried over into the bankruptcy arena, and the debtor keeps the privilege. This means that the trustee cannot compel the debtor to disclose what the attorney told him, and, conversely, the attorney cannot be forced to reveal client confidences. However, in the case of corporate bankruptcy filings, the privilege belongs to the corporation, and not the individual officers, directors or shareholders. In that event, the trustee can compel the disclosure of all privileged communications, because the privilege passes to the trustee upon the bankruptcy filing. This can result in the disclosure of items which can be potentially damaging to the officers, directors, and shareholders, on an individual basis.

     The issue of privilege should be analyzed carefully before any bankruptcy filing, so that the client will have full advance knowledge of what to expect upon a bankruptcy filing, especially when it involves a corporation.

Written by Henry Rendler





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