File Chapter 7 Bankruptcy or Do Nothing?
Filing bankruptcy can be a lengthy process and require a good deal of effort on the part of the debtor. For this reason, my Lexington, South Carolina clients sometimes ask why they should expend the money and effort of filing Chapter 7 bankruptcy. “What can my creditors do if I don’t file?”
When the client is considering Chapter 7 because he finds himself unable to pay his unsecured debts–credit cards, medical bills, retail charge accounts, and so on–this is a very good question. Because an unsecured creditor holds no lien on any collateral and therefore has nothing to repossess, its only legal remedy is to sue the debtor. If it succeeds in the lawsuit–and it probably will if the debtor actually owes the debt–the result is a judgment. But a judgment doesn’t necessarily produce money for the creditor or take anything from the debtor. The debtor loses something only if the judgment creditor identifies property or possessions of the debtor that it can have the county sheriff sell.
Every state allows a debtor certain exemptions–some basic property the state legislature has decided creditors may not reach. For example, in South Carolina, creditors can’t reach the first $50,000 or so of equity the debtor holds in his home, the first $5,000 of equity in a car, or take certain other property which is protected. For the most part, the same property is protected against a judgment creditor as is protected against a Chapter 7 bankruptcy trustee. In the great majority of Chapter 7 cases, the trustee is not able to locate any of the debtor’s property that is not protected by exemptions. This means a judgment creditor could not, either–at least not right now. So again the question arises: If I can’t protect anything more in bankruptcy than I could if I do nothing, why should I file?
In my view, there are only two reasons. The first is a technical, legal one. A judgment remains in force for ten years. If the debtor acquires non-exempt equity in any asset during those ten years– if he pays off a car loan and thereby increases his equity in the car beyond $5,000, or if he pays down his mortgage and his home appreciates such that his equity exceeds $50,000–a judgment creditor may be able to reach this increased value. The creditor could obtain an execution or levy under which the sheriff must seize and sell the asset, applying the proceeds to the judgment debt. By comparison, in bankruptcy, creditors get a one-time snapshot of the debtor’s assets. With narrow exceptions, bankruptcy law says that only the things the debtor owns as of the filing date are answerable for his past debts. If he acquires property or increases his equity in property after filing bankruptcy, he benefits from that improvement in his position, not his creditors. This is one reason bankruptcy is referred to as a fresh start. It allows debtors to acquire property in the future that cannot be taken away for past debts.
The second reason is a practical, human one. For many people, the pressure of aggressive creditors and debt collectors becomes a major quality of life issue. A recent research study by two law professors concluded that most people are driven to bankruptcy not by any sudden, catastrophic event but rather by the relentless, depressing pressure of collection calls and letters. In fact, the same study found almost 70% of people struggle with serious financial distress for a year or more before considering bankruptcy, but eventually they are worn down by the relentless drum beat of creditor harassment. R. Mann & K. Porter, Saving Up for Bankruptcy, 8 Georgetown Law Rev. 289 (2010). Filing bankruptcy, by contrast, means that creditors must immediately cease virtually all collection activity by force of the automatic stay set out in Section 362 of the Bankruptcy Code. Most of my clients find this a welcome relief.
If you are relatively sure your asset picture will not improve substantially in the next ten to twelve years, and if collection pressure does not bother you, there may indeed be no reason to file Chapter 7 instead of doing nothing. But if you want a fresh start, free of collection pressure and free of the drain of past debt, you may want to consider Chapter 7.
Not everyone’s situation fits Chapter 7. Do not consider filing bankruptcy until you have thoroughly reviewed you entire financial situation with an experienced bankruptcy attorney. In addition, exemption laws can be complicated. The exemptions discussed in this post are approximations and are given for illustration purposes only.