10 Misconceptions About Bankruptcy
Neil E. Colmenares
2005 - Bankruptcy law is complex and takes time to master.
A basic understanding of the Bankruptcy Code and its principles
is essential for effective management of the financial affairs
of individuals and businesses. There are many misconceptions
The debtor must be flat broke to file for bankruptcy.
Wrong. With limited exceptions, the only requirement to
file for bankruptcy is that the debtor cannot pay bills
as they come due. A “debtor” is an individual
or entity that owes money. The Bankruptcy Act of 1898 (replaced
by the Bankruptcy Code of 1978) substituted the term “bankrupt”
for “debtor.” One reason for this change was
to help remove some of the social stigma involved in filing
for bankruptcy. Most people are debtors, but not all are
a “flat broke” debtor would complete the bankruptcy
process, she would in all likelihood become a public charge
because she has nothing left to live on. To avoid this burden
on the government, Congress has permitted exemptions that
allow debtors to keep a certain amount of property despite
filing for bankruptcy. A person filing for bankruptcy in
New York is permitted to have, among other things, up to
$2,500 in cash, $2,400 of equity in an automobile, and unlimited
funds in a qualified 401(k) plan. (For a complete list of
exemptions for New York State debtors domiciled in New York,
see the New York CPLR sections 5205 and 5206, New York Debtor
and Creditor Law Sections 282–284, and the New York
Insurance Law sections 3212–3213.)
because individuals and businesses often wait until they
are flat broke to seek bankruptcy advice, this delay limits
their options, some of which may help them reorganize their
finances and keep part or all of their property. For example,
an individual normally waits until the day before a foreclosure
sale to seek bankruptcy advice; had he sought advice earlier,
his chances of losing the property would have been diminished
An individual who files for bankruptcy will not qualify
for credit in the future. Wrong. The fact
that an individual files for bankruptcy will appear on an
individual’s credit report for up to 10 years, which
may seem draconian but is not permanent.
individual considering filing for bankruptcy probably has
poor credit already. Filing for bankruptcy may be the best
bet to “get good credit” again, because when
a debtor files for bankruptcy under Chapter 7 of the Bankruptcy
Code and receives a discharge (a court injunction relieving
the debtor of the obligation to repay most debts and preventing
creditors from collecting for the same), the debtor cannot
receive another discharge under Chapter 7 for at least six
for example, a credit card company that receives two applications,
identical with one exception: one applicant filed for bankruptcy
three months ago. Who should it extend credit to? Applicant
#1, who never filed for bankruptcy and who could file for
bankruptcy at any moment after using the credit card company’s
money? Or Applicant #2, who filed for bankruptcy three months
ago and who recently received a discharge under Chapter
7, thereby ensuring that the loan cannot be discharged under
Chapter 7 for at least the next six years? This scenario,
in practice, often results in an individual who filed bankruptcy
last week receiving dozens of new credit card offers.
An individual who files for bankruptcy cannot buy a house.
Wrong. Like all lending institutions, mortgage
lenders are willing to take risks with a debtor as long
as the lender has enough security. This generally means
charging higher interest rates and requiring personal guarantees.
If a person who had filed for bankruptcy in the past applies
for a mortgage and can fund a sufficient down payment, most
banks will approve a mortgage loan.
A homeowner who files for bankruptcy will lose her house.
Yes and no. In New York State, under what is called the
“homestead exemption,” an individual is allowed
to keep the first $10,000 in equity in her home above all
liens and encumbrances despite the bankruptcy filing (the
exemption is $20,000 for joint debtors).
example, consider an individual who is current on his mortgage
payments, has little equity in the property, and has a lot
of credit card debt. Assume that the property is worth $250,000
and the mortgage is $240,000. In this instance, the individual
can file for Chapter 7 and keep the house.
however, that the same individual has a $200,000 mortgage
on the property. After taking into consideration the $10,000
homestead exemption, the individual is left with $40,000
in nonexempt equity. If this individual files for Chapter
7, the trustee in the case will sell the property and the
individual will be given the first $10,000 from the proceeds.
(A trustee is a person appointed by the court to administer
the debtor’s estate. The trustee’s main function
is to sell the debtor’s nonexempt property and use
the proceeds to pay creditors.) The point is that the individual
will lose the house under Chapter 7 unless, after filing
for bankruptcy, he can come up with $40,000 to pay the trustee
the nonexempt equity. These funds can come from a post-petition
mortgage or from a loan by family or friends.
consider an individual who is behind on her mortgage, has
substantial equity in the property, and has a lot of credit
card debt. In this scenario, assuming the individual has
a regular source of income and, after paying her regular
monthly bills (i.e., mortgage payment not including arrears,
food, and utilities), any money left over can satisfy the
arrears on the mortgage over a period of not to exceed five
years, the individual may be able to keep the house in Chapter
13. Although Chapter 13 is complicated, the principle is
simple: As long as an individual repays the debt, she can
keep the property.
Taxes cannot be discharged in bankruptcy.
Wrong. Certain taxes are dischargeable in bankruptcy, such
as personal income taxes that are more than three years
old. As a general rule, fiduciary taxes are not dischargeable.
The Bankruptcy Code’s provisions relating to taxes
are complex, and differ by chapter.
Student loans are nondischargeable. This is
generally true, but with exceptions. If the debtor can prove
certain hardship, student loans may be dischargeable.
An individual can file for bankruptcy but not include certain
creditors. Untrue, unlawful, and fraudulent.
One principle behind the Bankruptcy Code is to treat similarly
situated creditors equally. When a debtor does not list
a creditor in bankruptcy and decides to pay back that creditor,
that debtor is necessarily prejudicing the other creditors.
When a debtor does this, the court considers this fraud,
and the debtor risks losing the discharge and, in extreme
circumstances, may face jail time and substantial fines.
Family members who loaned money to the debtor will lose
out. Wrong. Although a debtor must list all
creditors in the bankruptcy, in certain instances the debtor
can repay certain creditors after the bankruptcy is filed.
This is commonly known as a reaffirmation agreement. All
reaffirmations are subject to court approval. Most debtors
agree to pay back a debt they have no legal obligation to
pay so as to maintain an existing business relationship.
The court would probably approve the reaffirmation if the
debtor lives with the creditor and may be forced to leave
if he does not repay the debt.
Signing an agreement stating that a debt cannot be discharged
in bankruptcy makes the debt nondischargeable. Wrong.
Although there are extremely limited exceptions, these bankruptcy
clauses are unenforceable and are a tactic used to scare
debtors into not filing bankruptcy.
A person can lose his job if he files for bankruptcy. Wrong.
The law states that if an individual can prove that an employer
fired an employee solely because the employee filed for
bankruptcy, the employee can sue the employer. If the debtor/employee
looks for another job after filing for bankruptcy, however,
a potential employer can use the bankruptcy filing as a
factor (not the sole factor) in deciding whether to employ
E. Colmenares, Esq., is in private practice with
offices in Queens, Nassau, and New York Counties. He is admitted
to practice in the courts of the State of New York and the
U.S. District Courts for the Eastern and Southern Districts
of New York. He is a member of the American Bankruptcy Institute,
the Nassau County Bar Association, the New York County Lawyers
Association, and the Queens County Bar Association.
can be reached at 718-888-3108, 516-739-7272, 212-563-2222,