What You Should (And Shouldn’t) Do Before Filing Chapter 13 Bankruptcy In California

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In this article, you will learn …

• Why filing for bankruptcy is wiser than trying to negotiate with creditors.
• Financial moves to avoid before filing for bankruptcy.
• Whether or not it’s best to wait before you file for Chapter 13.

Why Should (Or Shouldn’t) I Try To Negotiate With Creditors Before Filing Chapter 13 Bankruptcy?

If you try to negotiate with a creditor prior to filing for Chapter 13 bankruptcy, the Chapter 13 plan will supersede any agreement you reach. Your creditor will assume that you conducted the prior negotiations in bad faith. And when it files its proof of claim in your bankruptcy case, it will list the balance you had prior to the negotiations, plus any accrued interest and penalties. In sum, you will have accomplished nothing.

The key to successful negotiation is, of course, to convince the person on the other side of the table that you are proposing a deal that is the very best that person can get. Appeals to mercy or compassion will fall on deaf ears. In light of that key, there are two main problems with negotiations.

The first problem is called the free rider problem which is only a problem if you have more than one creditor. Each creditor will demand either full payment or a high percentage payment, and tell you to give the other creditors a greatly reduced payment.

The second problem arises if you have assets that could be liquidated to pay your debts. The obvious question is: “Why should I accept less than full payment when you could sell assets, or borrow money secured by those assets, and pay me in full?”

For example, suppose you have $500,000 in home equity. Although the equity may be completely exempt in bankruptcy, outside of bankruptcy the creditor may insist that you take out a home equity line of credit to pay the debt in full.

In sum, if you are planning to seek Chapter 13 relief, it is better not to waste time negotiating with creditors and simply file for Chapter 13 bankruptcy with the help of an attorney.

Which Debts Should I Stop Paying Before Filing Chapter 13 Bankruptcy?

Before addressing the question directly, we need a little vocabulary.

In the taxonomy of debt there are different ways to break things down. One way is to distinguish between secured debts and unsecured debts.

Secured debts are debts that are secured by an asset such as a car or a house. If you don’t make the payments, the creditor will repossess the car, or foreclose on the house. The car, the house, serve as collateral securing the debt.

Unsecured debts are debts that are not secured by an asset. Examples of unsecured debts include credit card debt, medical debt, and obligations to pay child support or alimony.

In the realm of unsecured debts, Congress, in its exceedingly finite wisdom has given better treatment in bankruptcy to some it has labeled as priority unsecured debts. See 11 U.S.C. § 507(a) for the complete list. Priority unsecured debts must be paid in full in a Chapter 13 plan, even if the nonpriority debts get less than 100%.

If you want to keep the collateral, you should continue paying the debt secured by the collateral. And if you have priority unsecured debts, it’s probably best to continue paying them. Otherwise, the balances will grow, which could mean that your Chapter 13 plan payments will be higher than they might have been.

You should also continue paying a debt you recently incurred as part of aging it before filing for bankruptcy. Otherwise, the creditor in question may challenge the discharge of the debt under a theory of fraud. The length of aging (and the number of prepetition payments) depends on three factors: The identity of the creditor, what you used the money for, and how you incurred the debt. We do prebankruptcy planning at our first appointment by doing a detailed analysis of your credit card and loan statements, paystubs, and bank statements.

If you stop paying a debt, the creditor will call you daily. Your interest rate on that debt will increase, and penalties and interest will start to accrue at a rapid rate, increasing the amount you owe.

What Should I Avoid Doing With My Assets Before Filing?

Do not transfer an asset before filing a Chapter 13 petition, or a petition under any other chapter. Transferring an asset almost always falls under the definition of a fraudulent transfer.

In a Chapter 7, it will render you ineligible for a discharge; and the Chapter 7 Trustee will avoid the transfer and seize the asset to liquidate and pay creditors.

In a Chapter 13, the value of the transferred asset will go into determine the size of your plan payments. This is because the minimum you can get away with repaying your creditors over the life of a Chapter 13 plan is the amount they would have gotten in a Chapter 7 liquidation i.e., the amount the Chapter 7 Trustee would pay them after liquidating the recovered asset.

There are two definitions of a fraudulent transfer:

1. A transfer is fraudulent if you did it with the intent to hinder, delay, or defraud a creditor.
2. A transfer is fraudulent if it’s done without getting a reasonably equivalent value in exchange for the transfer.

For example, if you have a $100,000 asset and you sell it to your brother for $10,000, then in a Chapter 7 case, the Chapter 7 Trustee will avoid the transfer and seize the asset to pay your debts. And in a Chapter 13 case, the starting point for the amount you must repay over the plan life is the value of the asset (minus the Chapter 7 Trustee’s costs).

You must disclose prepetition transfers in your bankruptcy petition. If you don’t, then when the FBI discovers the undisclosed transfer (yes, the FBI investigates bankruptcy cases), you may find yourself living rent-free in a federal penitentiary.

Trustees and Bankruptcy Judges are not stupid; they are invariably bright and have some impressive investigative tools at their disposal. If you transfer assets in anticipation of bankruptcy, you will be caught. In sum, don’t transferring assets ahead of filing a Chapter 13 bankruptcy petition.

Should I Wait To File Chapter 13?

On the one hand, to avoid challenges to the discharge of some debts, you may need to age debts and wait a while before filing for Chapter 13 bankruptcy. And if you have done fraudulent transfers, you may need to postpone filing until the relevant statutes of limitations have elapsed.

On the other hand, if you are close to the Chapter 13 debt ceilings for either secured or unsecured debts, you may need to file quickly. Otherwise, interest accrual could render you ineligible for Chapter 13 protection. If that happens, you may need to seek Chapter 11 protection. Although most Chapter 11 petitions are filed by businesses, individual debtors can obtain Chapter 11 relief.

Of course, waiting to file may increase your total debt balance because of accrued interest and penalties, and lead to higher plan payments, even if you are still eligible for Chapter 13 protection.

Why Should Or Shouldn’t I Transfer Property To Family Members Before Filing Chapter 13?

Do not transfer property to your friends, close business associates, or family members prior to filing. Reread my answer to “What Should I Avoid Doing With My Assets Before Filing?”

Why Should Or Shouldn’t I Take On New Debt Before Filing For Chapter 13?

When you take on new debt and file for bankruptcy soon after, your creditors may accuse you of committing fraud and not intending to pay them back. As a general rule, don’t incur new debt prior to filing for bankruptcy protection.

However, if your vehicle has died and you desperately need a vehicle to get to work or school, taking out a new debt to buy a reasonable vehicle (even with Chapter 13 bankruptcy looming) could be acceptable in the eyes of a trustee or a judge.

You may need to take out a retirement loan to reduce your total debt if you are in too much debt to qualify for Chapter 13.

Meet with a bankruptcy attorney and analyze your finances, debts, and material needs to determine if incurring a new debt would be acceptable.

Do I Need To Tell My Employer About My Bankruptcy Plans?

Unless your employer is one of your creditors, your employer does not need to know that you are planning on filing for bankruptcy. If a creditor is garnishing your wages, and you file a bankruptcy petition, the automatic stay stops the garnishment. Let your employer know about your filing so it won’t continue to deduct the garnishment from your paycheck.

Of course, your employer needs documentary proof of the filing. Your attorney can send your payroll office a letter with proof of the filing.

You needn’t worry about discrimination based solely on bankruptcy because Section 525 of the Bankruptcy Code prohibits workplace discrimination or termination solely on the basis of your filing for bankruptcy.

In most cases, it will not be necessary to let your employer know you are filing, and you can feel free to confine this information to close, trusted family and friends.

Why Should I Consult A Bankruptcy Attorney Before Filing For Chapter 13?

Although I read about a man who performed his own appendectomy, you really should not perform surgery on yourself. Similarly, you should not attempt bankruptcy by yourself. As the great Abraham Lincoln is reputed to have said, “The man who represents himself has a fool for a client.”

Bankruptcy can range from moderately complicated to extremely complicated; so it’s best to hire an attorney to ensure there are no complications, mistakes, or missed deadlines.

On a statistical basis, the Court is very likely to dismiss a pro se Chapter 13 debtor’s case. It’s easy to botch the case, sometimes so badly that it cannot be repaired. It’s far wiser to have an attorney help you from day one.

What Financial Habits Should I Adopt Or Avoid In The Months Leading Up To Filing For Chapter 13?

Stop incurring debt. During the first phone call, I give an important homework assignment to a potential client: Cut up all your credit cards. Then set them on fire but do it outside because the smoke is thick and acrid; and watch for falling birds. Don’t even think about incurring any new debt.

Develop a personal budget. Keep track of your expenditures and make budgeting a friendly family team effort. Stop spending on specialty coffee, trim out unnecessary expenses, and keep your spending limited to housing, utilities, transportation, and food. While you don’t need to live on a bowl of steam, or eat only once a day, it’s crucial to get your spending under control and not incur further debt leading up to filing for Chapter 13.

 Still Have Questions? Ready To Get Started?

For more information on Pre-Chapter 13 Dos And Don’ts, an initial consultation is your best next step. Get the information and legal answers you are seeking by calling (562) 777-9159 today.