Making Sense of Bankruptcy: The Role of Honesty

Bankruptcy works largely on the honor system.  Actually it’s closer to a “trust, but verify” system.

Here’s the sentence that we’re explaining in today’s blog post:

To get the benefits of bankruptcy, be honest and thorough with the bankruptcy process and with your creditors, which may not be as challenging as you might think.

The Benefits of Bankruptcy in Return for Honesty

Our blog posts in this website describe the many, many benefits of Chapter 7 “straight bankruptcy” and Chapter 13 “adjustment of debts.” Yes, when you file either kind of consumer bankruptcy you get immediate relief from virtually all creditor collection actions. And you get a permanent “discharge” (legal write-off) of most or all of your debts. But there’s so much more. Glancing through the titles and content in our recent “Making Sense of Bankruptcy” series will give you a sense of some these many, often surprising, benefits.

Here’s how the U.S. Supreme Court has described the basic point of bankruptcy:  

[A] central purpose of the [Bankruptcy] Code is to provide a procedure by which certain insolvent debtors can reorder their affairs, make peace with their creditors, and enjoy “a new opportunity in life and a clear field for future effort, unhampered by the pressure and discouragement of preexisting debt.”

To get this “new opportunity in life,” the bankruptcy system asks for one thing: your honesty. As the Supreme Court put in in the very next sentence following the one above:

But in the same breath that we have invoked this “fresh start” policy, we have been careful to explain that [bankruptcy law] limits the opportunity for a completely unencumbered new beginning to the “honest but unfortunate debtor.”

(From Grogan v. Garner, in 1991, with the quoted parts from a 1934 opinion.)

So what does the Supreme Court mean by “honest” here? If you’re considering bankruptcy you might be concerned about what you need to reveal, and about whether you can be “honest” in the way needed to get the benefits of bankruptcy. So it helps to know what’s really required here.

Basically two kinds of honesty count in the bankruptcy process: 1) honesty with your creditors WHEN you took out your debts (not so much later), and 2) honesty during the bankruptcy process.

The Benefit of Honesty with Your Creditors

When you file a consumer bankruptcy case—under either Chapter 7 or Chapter 13—most debts that you expect to discharge do end up being discharged. No creditor challenges the discharge of the debt, the debt is the kind that can be discharged, and the court’s discharge order results in the debts being discharged. So, you never have to pay all or most of our debts.

Certain select types of debts—such as recent unpaid income taxes, most student loans, and child support arrearage—can’t be discharged, regardless of your honesty or lack thereof.

The rest of your debts will be discharged, EXCEPT that your creditors MIGHT be able to challenge the discharge of ANY particular debt under very specific grounds involving your dishonesty or some similar bad behavior AT THE TIME you incurred the debt.

These challenges are pretty rare. The kind of behavior that brings out challenges to discharge are usually about lying about income on a credit application, using credit when not intending to repay it, intentionally writing bad checks, embezzlement, and causing intentional bodily harm or property damage.

The behavior at issue is what happened at the time you got the credit or became liable on the debt, NOT what happened afterwards, such as breaking promises you later make to a collection agent about paying the debt. Such more recent behavior usually does not expose you to challenges to the discharge of a debt.

So what’s crucial now when you are considering bankruptcy is to be honest with your bankruptcy attorney. To get good advice about how best to deal with your overall financial situation, and to find out if you have any genuine concerns about any possible challenges to the discharge of your debts, be candid and thorough with your attorney.

The Benefit of Honesty with the Bankruptcy Court

Your opportunity to be honest in the bankruptcy procedure is mostly through paperwork–the bankruptcy petition and related documents that you sign under penalty of perjury and are filed at court, plus certain documents like pay stubs to verify your income. Plus you attend a short (usually less than 10 minutes) meeting with a bankruptcy trustee, where with the help of your attorney you answer a few questions, mostly about the paperwork that was submitted.  

As mentioned at the beginning of this blog post, it’s mostly an honor system, one built on the assumption that the paperwork submitted on your behalf and the oral answers you provide are honest. There is a certain amount of verification involved, again mostly on essential financial information like your income, and perhaps some of your assets. And the various actors—the trustee, your creditors—have the right to follow up on anything relevant or suspicious.

You have to honest with the system or else your ability to get a discharge of ANY of your debts is put at risk. For example, if you are found to hide an asset or to exclude a major prior transaction or creditor from the paperwork, your case can get thrown out and you could lose all of the benefits of bankruptcy.

Likely Nothing to Worry About

But being upfront and honest as required is usually not all that hard. Most people who need bankruptcy relief get what they need because their true circumstances allow for it. For a bunch of reasons you may feel guilty or fearful or concerned about not paying some or all of your debts, and so are worried about what it takes to accomplish this. Much of the time people are pleasantly surprised about what the bankruptcy laws provide for them.

Again, the key is to be candid and thorough with your attorney. Why? He or she can only give you good advice if you give him or her your story, and if you raise issues you’re concerned about. Most of the time, you’ll get reassurance that what you were worrying about was less of a concern than you thought. Or you’ll get a game plan for addressing the situation in the best way possible. You’ll not only help your case proceed much more smoothly, you’ll be more relaxed about it.

As the Supreme Court said, the goal is to give you “a new opportunity in life and a clear field for future effort, unhampered by the pressure and discouragement of preexisting debt.” Honesty with the bankruptcy process will usually get to this result.