Just about everyone acknowledges that the economy has been rough for the last couple of years. Bankruptcies are being filed more than ever, and nearly everyone knows someone going through the process. It may surprise you to learn that filing for bankruptcy is something that even happens among the rich and famous. Money troubles with the wealthy tend to be much more extravagant, and if the individual is famous enough, it’s likely that their bankruptcy story is headline news. In fact, quite recently two major players in the sports world have had to file bankruptcy – that’s right, even millionaires run into money troubles.

A former football player by the name of Warren Sapp ran into one of the most common problems of bankruptcy – he made too many unwise purchases. Warren Sapp’s bankruptcy case is a great example to study because his mistake is very obvious. Sapp was an avid collector of paintings, a luxury that, in combination with a series of poor real-estate choices, led to his downfall.

With April 15 just around the corner, many of us will be scrambling to come up with money to pay Uncle Sam.  For those who are self employed, estimated tax liability payments are due every quarter.  The IRS does allow you to pay your tax debt with a credit card, but you can expect to pay a “convenience fee” of around 2% of the amount charged. for this option.

Further, if you do use your credit cards to pay your tax debt, the Bankruptcy Code specifically disallows that part of your credit card debt to be discharged in a bankruptcy case, unless the tax you are paying is dischargeable as well.

The Bankruptcy Code is silent as to how long the non-dischargeability status remains associated with credit card debt when you continue to use and make payments on that credit card for several months prior to filing for bankruptcy, and that makes for some interesting conjecture.

Consider, for example, a situation where you use your credit card on April 14 to charge 2011 tax debt of $10,000.  The bill for April arrives on May 5 and you make minimum payments and partial payments totaling $7,500 for the next few months.  You also continue to use the card for buying food, gasoline and other necessities.  In November, you file Chapter 7 with the balance on your credit card at $12,000.  How much, if any, of that $12,000 balance is non-dischargeable per Bankruptcy Code Section 523(a)(14) or (14a)?

What happens if some of your tax debt is dischargeable and some is not – how would a bankruptcy judge rule on a dischargeability complaint?  Would you exit bankruptcy still owing $10,000, $5,000, nothing?

Some of these questions have answers and others do not, however the time to consider these issues is as far in advance of a possible bankruptcy filing as possible.  If you are considering using a credit card to pay tax debt, it would not be far fatched to conclude that filing bankruptcy may be a possible future course of action.  It would therefore be wise to schedule a meeting with a bankruptcy lawyer to consider a variety of “what if” scenarios.

Over the past couple of years I have noted an unsettling trend in my Chapter 13 cases.  Trustees in the Northern District of Georgia are scrutinizing budgets line by line and are objecting to budget items in an attempt to force debtors to increase their trustee payments.

I am even receiving objections to the total amount of expenses claimed.  In a recent case, for example, the trustee filed a supplemental objection a week before confirmation which asserted that the debtor’s total claimed monthly expenses were too high.  When I called, he pointed out four or five specific line items and I obtained and presented supporting documentation from my client.

My client advises me that he is literally having difficulty buying food and the trustee acknowledged that our claimed expenses were legitimate but he would not back off his objection because the total payout to unsecured creditors was less than 50 cents on the dollar.  There is no resolution yet, but we agreed to reset the confirmation until after the date that all claims are due – presumably some of the unsecured creditors will not file claims, meaning that the ones who do will receive a higher payout.

I would note that no creditors have filed any objections and my client is paying well over $1,000 per month.

It appears that the trustees in the Northern District of Georgia are expecting that Chapter 13 plans should pay at least half, if not more, to unsecured creditors.  I am not blaming our Chapter 13 trustees – I suspect that they are given their marching orders by the U.S. Attorney’s Office and others in the Executive Branch of government.

I have several concerns with this development:

First, the net effect of the trustee’s approach is to squeeze middle class families – those with household incomes of $80,000 to $120,00 per year.  These folks will usually fit into Chapter 7 because of the means test, their pre-filing lifestyles usually produce significant (i.e., $20,000 ore more) of unsecured and credit card debt, but their monthly expenses are such that they do not have enough left over to pay a huge percentage back to unsecureds.  Further, this type of debtor tends to delay filing because they do see bankruptcy as a last resort.

Second, the budgets that the trustees are demanding do not account for unexpected expenses and emergencies that anyone will face over the course of 5 years.  In other words, these plans are almost set up to fail.  I don’t see that creditors, debtors or the economy as a whole benefits when honest, hardworking debtors are forced to commit to a repayment plan that will be almost impossible to fulfil.

Third, this trustee policy creates a disincentive for people to file Chapter 13 cases.  I have had debtors say to me “why shouldn’t I just quit my job, wait a few months until I meet the means test, then file Chapter 7 as opposed to working like a dog to keep a Chapter alive when the deck is stacked against me?”  While this type of activity would be considered unacceptable “income suppression” by the United States trustee, I fear that the Chapter 13 trustees’ hard line approach may encourage people to take the risk.

I once had a long conversation with one of the attorneys in the United States’ trustee’s office who told me that their policy was to discourage Chapter 7 cases and encourage more people to file Chapter 13, where they could pay at least some of their debts.  I think its time that the U.S. Trustee and the Chapter 13 trustee reconsider the punitive nature of how they look at Chapter 13 cases and create a framework where these cases have a better likelihood of working.  Accepting budgets that allow for emergency expenses would be a good start as would backing off when no creditor is objecting is another.

There is no perfect time to file for bankruptcy.  Ideally, you should wait to file at a point when you have not touched your credit cards for several months and your credit card charges over the past year have not taken a big jump.  Further there is less chance that you will face any objection if you have made at least the minimum payment over the past 6 months or longer.

Section 523 of the Bankruptcy Code sets out a number of situations in which credit card debt will not be discharged.  Section 523(a)(2)( c) makes non-dischargeable consumer debt totaling more than $500 for luxury goods and services owed to any one creditor that are incurred within 90 days of filing, or cash advances totaling $750 or more owed to any one creditor made within 70 days of filing.

Section 523(a)(2) makes non-dischargeable debt owed to a creditor that was incurred by false pretenses or by fraud.

Basically, then, Section 523 gives credit card lenders at least two arguments to challenge a debtor:

1. recent credit card use (within 3 months) for anything but necessities like food, clothing and shelter
2. any credit card use in the recent past (in my experience this can be up to a year prior to filing) if a debtor makes charges where there is no reasonable expectation of repayment.   

Another way to look at this – if you have lost your job and for the last year your sole source of support are credit cards and cash advances, you should not expect to avoid a challenge by the credit card issuer just because you wait 91 days after your last use of your cards.

What, then, should you do if you need to buy food or gasoline in the weeks before you actually file?

First, you should recognize that shortly after you file, there is a very good chance that your credit cards will all be canceled and you are going to have to find another way to pay for your food and gasoline.  A bankruptcy may eliminate old debt but it will not help you pay your current or on-going bills.

Second, I advise my client that if they have to access their credit in the weeks and days before filing, I would choose one card – preferably a low interest card – and use that one only.  Expect that even if this card was used for food, gasoline and other necessities that you will have to pay some or all of it back.  If you can walk away from bankruptcy with 90% of your debt discharged, you will be better off than you are today and it is possible that any one creditor may not pursue a non-dischargeability complaint.

Three, as a practical matter you are not going to want to spend the money litigating Section 523 dischargeability actions.  Bankruptcy litigation is expensive and if you are scraping to buy food and gasoline, you will be able to afford litigation.  The fee you pay your bankruptcy lawyer will almost never include litigation.

Four, it is not always the worst idea to reaffirm one credit card, especially if it has a low balance and low interest rate.  Keeping one card can help you rebuild your credit quickly and some lenders will be open to aggressive negotiation on your part about balances and interest rates.

In my Atlanta area practice I often meet with a potential client weeks or months before we actually decide to file.  As such I encourage potential clients to call me as soon as they have any thoughts that bankruptcy may be even an unlikely option.  The more time we have to evaluate options and engage in pre-bankruptcy planning, the better.