The Benefits of Bankruptcy

Last weekend I watched the movie Larry Crowne, starring Tom Hanks and Julia Roberts.  In the movie, Tom Hanks plays a character that had recently been terminated for his job due to his lack of formal education, so he decided to go back to community college to remedy the situation.  He took an economics class there with an eccentric professor.  One day, the two of them were outside the school having a discussion on whether there were any economic benefits to filing for bankruptcy, I believe with Tom Hanks arguing that there were not and the professor arguing that there were.  Granted, this was not the focus of the film (and I haven’t known bankruptcy to be a topic discussed in economics classes – I didn’t discuss it in mine), but the professor was right.

Bankruptcy is not something that a person should strive for.  We all know that.  However, for the honest debtor who finds himself or herself in a truly difficult financial situation which is unanticipated, bankruptcy does operate as a “fresh start,” which is its stated goal.  What I generally mean by an “honest debtor” is a debtor who is not committing fraud by doing something like running up credit card debts in anticipation of bankruptcy, but that’s for another blog entry.  In this entry, I will be referring to consumer bankruptcy.

The most pervasive aspect of the fresh start is through the discharge under section 523.  A bankruptcy discharge simply relieves the debtor from any further personal liability for the debts covered by the discharge.  A bankruptcy discharge does not, however, eliminate the debts: the ability of creditors to look to other parties such as guarantors and insurers is unaffected.  And, a bankruptcy discharge does not eliminate liens: the ability of secured creditors to look to their collateral is unaffected.

There is also the automatic stay under section 362.  This means that from the moment you file for bankruptcy, your creditors cannot attempt to collect the debts that you owe them.  They cannot send you letters or call your phone (by the way, even if you don’t file for bankruptcy, creditors are required by law to obey you if you tell them to stop calling your cell phone at any time, though you can’t make them stop calling your home phone without the automatic stay).  They also cannot do things like terminate your utilities with the automatic stay protection.  A creditor can be held in contempt for violating the automatic stay.   

In certain situations, bankruptcy can also help a debtor’s credit score.  This is because individuals who file for bankruptcy in the first place typically have low credit scores in the first place, often with things like late payments and charged-off accounts.  When consumers receive the bankruptcy discharge, the items will be marked as included in a bankruptcy, rather than showing a high account balance, or otherwise being a bad debt.  To be certain, this is not always the case; in a generic sense, the bankruptcy filing, in and of itself, will lower a consumer’s credit score.  It is only the effect on the consumer’s other accounts that can sometimes improve a credit score.  I should also mention that bankruptcy discharge can only stay on a credit report for ten years. 

There is also plenty of free assistance for those who need it.  I spent my summer in 2011 working only on pro bono bankruptcy cases.  They were referred to us by Legal Services of Northern Virginia.  The individuals who received the pro bono assistance did not get the bankruptcy representation for absolutely nothing – they still had to pay small fees to, among other things, pull their credit reports.  They did not, however, have to pay several thousand dollars in fees, which is typical of a bankruptcy filing. 

Bankruptcy is not always a bad thing.  For the honest debtor who finds herself in a difficult economic situation, it can provide a fresh start, free of phone calls from creditors and personal liability for debts.  Though it is often expensive to hire a bankruptcy attorney, there are often programs (such as those in Northern Virginia) to provide assistance to those who cannot afford the attorney’s fees.  Based on the complexities of the bankruptcy code, though, it is probably not a good idea for most debtors to file bankruptcy pro se (without legal representation).

Thanks for reading.  I’ll be back with a new post within the next few weeks.

J.P. Morgan