Bankruptcy is a legal process by which eligible individuals may reduce or eliminate their dischargeable debts. There are different types of bankruptcy including consumer bankruptcy and business bankruptcy.
Consumer bankruptcy is for individuals who cannot meet their financial obligations due to debt they incurred for their personal needs. There are two main types of consumer bankruptcy, a Chapter 7 and a Chapter 13.
A business bankruptcy is for individuals or their businesses to obtain relief from their debts. There are two main types of business bankruptcy, a Chapter 7 and a Chapter 11. The Chapter chosen depends on whether the small business is the individual or a corporation or LLC.
If the small business is an individual, they would file under Chapter 7. If the business is a separate legal entity, such as an LLC, they would file under Chapter 11.
What is Pre-Bankruptcy Planning?
An individual who is facing creditors may take steps to protect their assets prior to filing for a bankruptcy. The main way to legally protect any assets is to convert those assets that are not exempt in a bankruptcy to assets that are exempt.
For example, converting a non-exempt retirement account into an exempt retirement account could shield that money from creditors.
What is Exempt and Non-exempt Property in Bankruptcy?
Bankruptcy provides a debtor with somewhat of a fresh financial start while, at the same time, assisting creditors to establish their rights on certain claims. As a general rule, once a bankruptcy has been filed, creditors are not permitted to attempt to collect or to collect on debts.
A creditor must wait until the bankruptcy process is complete prior to attempting any collection efforts. This is called an automatic stay, which is issued by a bankruptcy court at the outset of the proceedings.
An automatic stay is put into place partially because debt payments are often reevaluated and reorganized during a bankruptcy. Additionally, there are types of property that cannot be claimed by creditors in order to satisfy an individual’s debts, known as exempt property. There are other types of property that may be reached by creditors, known as non-exempt property. What types of property are considered exempt and non-exempt may vary by state.
Exempt and non-exempt property classifications most often arise in a Chapter 7 bankruptcy, or a liquidation bankruptcy, because the individual liquidates most of their property in order to satisfy their debts. The property the individual must forfeit is sold to satisfy the debts they owe.
Property and items that are classified as exempt and non-exempt are known as bankruptcy exemptions. Property that is non-exempt may be claimed by a creditor.
Federal bankruptcy laws permit each state to have discretion regarding which assets the debtor may keep when they file for bankruptcy. A state may permit the debtor to choose between federally-created exemptions or state-created exemptions.
In some cases, such as in Montana, a state will limit a debtor to only the state-created exemptions. An individual filing for bankruptcy can use the exemptions from only one statute, either the federal or the state, but not from both.
Exempt assets for Chapter 7 bankruptcy purposes include, but may not be limited to:
- Necessary and essential items, including:
- furnishings; and
- household goods and appliances up to a reasonable amount;
- Motor vehicles up to a certain specified value;
- Jewelry up to a specified value;
- Tools or instruments essential to an individual’s trade, up to a specific amount;
- Certain unpaid but earned wages;
- Pensions; and
- Benefits, including:
- social security;
- welfare; and
- unemployment, if the benefits are held in a bank account.
Examples of non-exempt assets for Chapter 7 bankruptcy purposes include, but may not be limited to:
- Bank account funds;
- Securities, including stocks and bonds;
- Valuable items, such as coin or stamp collections;
- Musical instruments, unless the individual is a professional musician;
- Second homes;
- Vacation property; and
- Second motor vehicles.
It is important to note that the items included in each list may vary by state and by which statute the debtor chooses, the federal or the state. Additionally, the amounts for the items will vary depending on the same factors.
Is There Legislative Support for Pre-Bankruptcy Planning?
Most state laws and federal bankruptcy laws permit the conversion of non-exempt assets into exempt assets. This conversion is not considered fraudulent and permits the individual to take advantage of any existing exemption guidelines.
Legislation permits an individual to engage in this conversion whether it is done in contemplation of filing for bankruptcy or with the intention of placing those assets beyond the reach of creditors. Some states, however, have placed state level restrictions on these types of transfers. Courts have ruled that these types of transfers done on the eve of a bankruptcy are, in fact, fraudulent transfers.
While the majority of federal courts have held that the federal bankruptcy law preempts any state law restrictions, those decisions have not been uniform. Additionally, there is a split decision on whether or not the federal laws preempt the state restrictions in state courts.
In other terms that are not complex legal jargon, an individual should hire an experienced local bankruptcy attorney to assist them prior to filing for their bankruptcy. An attorney can review and explain these complex nuances in the law in the event that the individual does want to convert an exempt property into a non-exempt property.
How is the Propriety of Pre-Bankruptcy Planning Assessed?
When evaluating whether or not a prebankruptcy transfer is permitted or fraudulent, the court generally considers whether the debtor or the transferor:
- Retained control or possession of the property transferred following the transfer;
- Concealed the transfer or obligation;
- Absconded; or
- Removed or concealed assets.
What are the Penalties for Improper Pre-Bankruptcy Planning?
A court may impose one of several penalties if an individual engages in improper bankruptcy planning, including:
- Complete denial of the bankruptcy discharge;
- Denial of the exemption either on the state or federal level; and
- Dismissal of the bankruptcy petition.
What will my Attorney Need at a Pre-Bankruptcy Planning Meeting?
Essentially, everything but the kitchen sink. An attorney will need to examine every aspect of an individual’s financial situation in order to provide a complete and accurate opinion regarding their position for bankruptcy. The attorney may wish to see documentation including:
- Any recent bills, mortgage statements, and other debt-related documents;
- Bank statements;
- Foreclosure or eviction notices;
- Letters or other correspondence from debt collectors;
- Legal documents relating to debt collection, especially any lawsuits or judgments;
- Insurance policies;
- Titles to vehicles and real estate;
- Check stubs and tax returns; and
- A current mortgage or lease.
It is important to share any requested information with the attorney. It is not done in an attempt to be nosy, it is done out of necessity in order to avoid being untruthful to the bankruptcy court.
Do I Need a Bankruptcy Attorney?
It is essential to have the assistance of an experienced bankruptcy lawyer for any bankruptcy issues you may have or if you are even just considering filing for bankruptcy. As noted above, the laws regarding prebankruptcy planning vary significantly depending upon the state.
Your attorney can review your assets and local laws and determine if conversions may be made and what property will be considered exempt and non-exempt. Having an attorney may mean the difference between having your bankruptcy dismissed or successfully discharging your debts.