At one time or another in your career as an advisor, you're likely to encounter clients who are thinking about filing for bankruptcy. Although clients must seek an attorney's advice to file, they may well consult you first. For this reason, I've compiled this list of bankruptcy basics financial advisors should consider before advising clients to consult a qualified bankruptcy attorney.
1) Types of Bankruptcy
There are six types of bankruptcy, each named for the chapter in the bankruptcy code that provides for its particular filing. Three are specific to a type of debtor (e.g., farmers or municipalities) and are used infrequently. The other three—7, 11, and 13—are the most common bankruptcy chapters.
Chapter 7 is a proceeding that requires an individual or corporation to liquidate all nonexempt assets to pay as much of the outstanding debt as possible. Thereafter, any remaining debt is discharged. Chapter 11 is a reorganization proceeding for a business, and Chapter 13 is a reorganization proceeding for an individual.
2) Potential Benefits of Filing
Your client will most likely ask you how exactly filing for bankruptcy will help his or her financial situation. Among the most important benefits is that it stops or substantially delays the foreclosure of an individual's home and may present the opportunity to make up back payments. This can relieve a major source of anxiety, especially if your client has a family.
Filing also prevents the immediate repossession of a car. In addition, once your client files, collection calls and creditor actions are stayed. This applies to lawsuits filed against your client as well. Depending on the chapter filed, it is possible to eliminate or "discharge" much of the outstanding debt, giving the individual a fresh start.
3) What Bankruptcy Can't Do
Several types of debt cannot be discharged in bankruptcy, including child support, alimony, and most divorce-related payments. Almost all types of student loans are nondischargeable in bankruptcy. Further, bankruptcy protection does not extend to the cosigner of a loan, so debt should be examined carefully. If a family member has cosigned the loan, the entire debt will be his or her responsibility, even though the original debtor's responsibility may have been discharged.
All debt incurred after the filing date is also nondischargeable, so be sure that your client understands that any credit card charges or loans taken out after filing will not be discharged.
4) Effects on Property
When considering bankruptcy, your client will probably want to know if he or she can keep any property. The answer depends on a number of factors, including the property's worth. The federal bankruptcy system has several exemptions that protect personal assets. Although this is not an extensive list, exemptions include:
- $15,000 in home equity
- $2,400 in equity in a personal automobile
- $400 per item in any household goods, up to a maximum of $8,000
- A small amount of jewelry
- Items needed for your client's job
In addition, most states supplement the list of federal exemptions, so your client should refer to his or her state's guidelines as well.
5) Requirements for Filing
Before filing, your client is required to attend two budget and credit counseling sessions and to file a certificate of completion of this requirement with the court. The sessions are conducted by approved credit counseling agencies, and at least one session must be completed in the 180-day period prior to the bankruptcy filing.
It's generally a good idea for your client to meet with a bankruptcy attorney before attending these credit counseling sessions, as the attorney may be able to identify an alternative to bankruptcy that is a better fit for the client. The court filing fee is only a few hundred dollars, but your client will be responsible for his or her attorney's fees.
6) Consequences of Bankruptcy
Although filing for bankruptcy may be the best solution, your clients shouldn't enter into it without a complete understanding of the consequences. Depending on the chapter filed, a bankruptcy can remain on your client's credit report of seven to ten years. The clock starts ticking when the case is filed, not when the case concludes. Bankruptcies can also affect a person's ability to obtain employment in certain professions and may result in the loss of some property in the process.
It's also important to note that, because bankruptcy is a public process, everything filed with the court becomes public record. Your client should carefully consider this privacy issue.
Keep in mind that the consequences of filing for bankruptcy will differ depending on the case and the chapter filed. With the consultation of a bankruptcy attorney, you can help clients understand bankruptcy and review their situation so that they make a well-educated decision.
Have you ever worked with a client who was considering filing for bankruptcy? Are there any other bankruptcy basics financial advisors should consider for their clients? Share your experience below.