Crucial Question: When Is It OK and Not OK to Use Credit In the Months Before Filing Bankruptcy?
So you’ve heard you can get into trouble if you use credit before filing bankruptcy. What are the rules about this?
The Benefits of Bankruptcy Go to the “Honest but Unfortunate Debtor”
As the United States Supreme Court said 80 years ago, the purpose of the bankruptcy laws is that “it gives to the honest but unfortunate debtor… a new opportunity in life and a clear field for future effort, unhampered by the pressure and discouragement of preexisting debt.”
The “honest debtor” incurs a debt with the intention of repaying it under the agreed upon terms. So a person who uses credit at a time when he or she does not intend to pay the resulting debt is not being an “honest debtor.” That’s particularly true, if, at the time he or she incurs the debt, that person is intending to file bankruptcy in the near future, and figures that this new debt will simply be added to what he or she is intending to discharge (legally write off) in bankruptcy. He or she risks not being able to discharge that debt.
The Timing of the Honest Intent is Crucial
To be clear, what counts here is the person’s intent at the time that the debt was incurred. And that includes at the time of any new cash advances or uses of a credit card. But we’re NOT talking about what the person’s intent about paying the debt is later when he or she is unable to keep paying the debt and may be thinking about bankruptcy. There’s no dishonesty if the original intent to pay the debt regretfully shifts later when circumstances change.
So if a person paid for a vacation on a credit card with the full intention of paying off that credit card, it’s that honest intention that counts. It helps if this intention was realistic, that the income from the person’s job was more than enough to make the increased credit card payments from the higher credit card balance. But if she later unexpectedly loses that job and can’t get another one with a similar income, it doesn’t matter that her intent at THAT point to no longer make the monthly credit card payments in order to be able to pay her home mortgage payment.
Proving Dishonest Intent
So far, you know that if you incur a debt with the intent at the time not to pay it, your later attempt to discharge that debt in bankruptcy may be challenged by the creditor. But how does a creditor know what your intent was?
Sometimes there are facts that give clues about your intent, like the pattern of your credit card purchases and that of your payments, such as if you make a string of purchases but then immediately made no further payments on that credit card.
But bankruptcy law acknowledges that it is hard for a creditor to prove a debtor’s intent to not pay a debt. So the law gives the creditors a hand with what are called a presumption of fraud.
Presumption of Fraud
Under certain very specific circumstances a presumption of fraud makes it easier for a creditor to stop you from discharging a debt. The creditor doesn’t have to start by presenting evidence showing that you didn’t intend to pay the debt. It only has to show that certain facts exist, facts which supposedly make it likely that you incurred the debt without intending to pay it. Under those facts the law presumes that you didn’t intend to pay the debt when you incurred it.
Here’s how the law does this with the two different presumptions of fraud, as applied, first, to purchases of “luxury goods or services” and, second, to cash advances.
The “Luxury Goods or Services” Presumption
If you charge on your credit card more than $650 in “luxury goods or services” (which generally means anything not “reasonably necessary”) through a single creditor within the 90 days before filing bankruptcy, that debt is presumed not to be discharged. The creditor does not, at least at first, need to provide evidence that you did not in fact intend to pay the debt for those “luxury goods and services.”
The Cash Advance Presumption
Or if you make one or more cash advances totaling more than $925 through a single creditor in the 70 days before filing bankruptcy, then the cash advances are presumed not to be discharged. The creditor does not, at least at first, need to provide evidence that you did not in fact intend to pay the debt for those cash advances.
Defeating the Presumptions
We said the creditor does not need to provide evidence AT FIRST, because you can challenge and defeat these presumptions by presenting evidence—including your own testimony, and other facts—showing that actually you DID intend to pay the debt at the time you incurred it. Then the creditor either gives up on its attempt at making you pay the debt, or else it presents whatever evidence it can that your intent was not to pay the debt when you incurred it. If the creditor does present its own evidence, the bankruptcy judge weighs both sides’ evidence and decides whose is more credible, and from that whether or not you will have to pay the debt.
Creditors Don’t Need the Presumption
If you use credit before filing bankruptcy but more than the 70 and 90 days applicable to these two presumptions, the creditor can still challenge the discharge of the debt with evidence that you didn’t intend to pay the debt. It just doesn’t have the advantage of the presumption.
Debts Are Discharged If Not Quickly Challenged
Any creditor who wants to challenge the appropriateness of your sues of credit must do so very quickly. Whether a particular pre-bankruptcy use of credit falls within the above two presumptions or not, if the creditor wants to challenge that use of credit it has to formally challenge the discharge of that debt, and do so by a very quick deadline. Otherwise the creditor loses its opportunity to do so forever. That deadline is generally only 60 days after the “meeting of creditors” in your case, which itself is about a month after your bankruptcy case is filed.
So within about three months after filing your case you will know whether any creditor will be challenging the discharge of any debt on the grounds that you accessed its credit too close to when you filed bankruptcy. That’s the same deadline for any challenges based on your alleged fraud, misrepresentation, and similar inappropriate behavior. You will quite quickly know whether any creditor thinks it should get paid in spite of your bankruptcy filing.
Discharge Challenges Are Uncommon
Rest assured that in the majority of consumer bankruptcy cases there are no such challenges by creditors to the discharge of debts. And in the occasional case when they occur, almost always it’s only by one creditor. And these are almost settled without going to a court trial, because the amount at issue is usually not enough for either side to spend a lot of money on attorney fees.
Avoid These Presumptions, Avoid These Discharge Challenges.
You can avoid giving a creditor the advantage of these presumptions by not using any credit and not making any cash advances when you start thinking about filing bankruptcy. Or at least hold off on filing bankruptcy until enough time has passed to get beyond these 70 and 90-day presumption periods. As just mentioned above, a creditor could still challenge your right to a discharge even without the benefit of a presumption. But if you avoid filing within the presumption period, that significantly decreases the chance that a creditor will bring a discharge challenge.