As you may suspect, the bankruptcy law provides that credit card lenders can challenge your discharge in certain circumstances.   You cannot, for example, go to an electronics superstore, buy a flat panel television and a $10,000 stereo system using your credit card, then file a bankruptcy the next week to wipe out the debt.

The Bankruptcy Code speaks to two situations in which credit card debt to a specific credit card lender can be declared non-dischargeable:

Recently incurred credit card debts

Bankruptcy Code Section  523(a)(2)(c) provides that the following debts are presumed non-dischargeable:

(I) consumer debts owed to a single creditor and aggregating more than $500 for luxury goods or services incurred by an individual debtor on or within 90 days before the order for relief under this title are presumed to be nondischargeable; and

(II) cash advances aggregating more than $750 that are extensions of consumer credit under an open end credit plan obtained by an individual debtor on or within 70 days before the order for relief under this title, are presumed to be nondischargeable

Credit Card Debts Incurred by Fraud or with No Realistic Expectation to Repay

Bankruptcy Code Section 523(a)(2)(b) allows a creditor to challenge the discharge of the following types of debts:

(A) [debts incurred by] false pretenses, a false representation, or actual fraud, other than a statement respecting the debtor’s or an insider’s financial condition;

Many people use credit cards as a means of survival.  Frequently, therefore, I see clients who desperately need to file bankruptcy but have used credit cards recently.  Not surprisingly, recent credit card use prior to bankruptcy is a problem – but just how big of a problem is it?

I recently received this question from a reader of my blog:

Hello, I had a question about chapter 7 bankruptcy. If I incur a lot of debt on my credit cards (like $30,000 worth) four or five months before declaring bankruptcy (for business expenses), could this be considered Bankruptcy Fraud?  In Massachusetts, the lookback period for credit cards is 90 days, but can it be extended further?

Here is my answer:  Bankruptcy Code Section 523 addresses this situation.  Section 523(a)(2) provides that:

consumer debts owed to a single creditor and aggregating more than $500 for luxury goods or services incurred by an individual debtor on or within 90 days before the order for relief under this title are presumed to be nondischargeable; and

In the Brumbaugh case, a debtor transferred an $18,000 balance from a high interest credit card to a new Chase credit card.  The debtor also used the Chase card for several small retail purchases including a few purchases made after she spoke to a bankruptcy lawyer.

After the debtor filed for bankruptcy, Chase filed a lawsuit in bankruptcy court (called a Complaint to Determine Dischargeability of a Debt) to argue that the entire $18,000 balance should be deemed "non-dischargeable" by the bankruptcy judge.  In other words, Chase wanted its claim to survive the bankruptcy and not be discharged.

Despite a fact pattern that looked pretty bleak for Mrs. Brumbaugh, the bankruptcy judge ruled against Chase.  While recognizing that this was a close call, the judge ruled in favor of the debtor because of the following:

1. most of the $18,000 balance was in the nature of a balance transfer, not new charges – under the bankruptcy law, balance transfers are not treated like new purchases
2. the debtor made the transfer in response to a Chase offer that gave her 0% interest
3. the transfer was made by the debtor who was going through a divorce and the debtor saw the lowered interest rate as necessary to get her financial house in order
4. the debtor and her spouse were trying to sell their house and planned to use the proceeds to pay down this debt.  The house did not sell, but the judge believed that the debtor had a reasonable plan
5. the debtor made payments to chase after the transfer – debtors who plan to defraud a creditor rarely make payments.

Obviously, not every judge would rule the same way as the judge did in the Brumbaugh case.  And Mrs. Brumbaugh had to pay a lawyer to defend her in this litigation.  My feeling is that if Mrs. Brumbaugh had been even slightly less credible and sympathetic, she would have lost.

Wendell closes his post by repeating a warning that I have been giving for years – if bankruptcy is an option, even a remote option, be very careful about making any significant financial moves until you have spoken to a lawyer.  For information about bankruptcy in St. Louis, take a look at Wendell's web site.

• his household income is below the median – so we do not have to deal with the means test
• his house is modest – valued at around $120,000 with mortgage debt equal to or above the value.  He is also prepared to surrender his house
• he has $70,000 in credit card bills – all fairly old
• he has $1,000 of medical debt

What, then, is the problem?

In February and March, my potential client  transferred the balance on several of his credit cards to new cards with lower interest rates.  Now, instead of having a lot of old debt, he has brand new debt in the form of what amounts to a cash advance.

Section 523 of the Bankruptcy Code says that cash advances totaling more than $750 within the 70 days prior to filing are presumed non-dischargeable.  (Jonathan notes that several astute readers emailed me to correct my error regarding the presumption of non-dischargeability for cash advances.   Cash advances in the weeks prior to filing bankruptcy are still not a good idea )  The transferee card issuer could object on the grounds that when the balances were transferred, my potential client knew or should have known that he was insolvent and that he would not be able to pay back these new debts.

My advice – start making minimum payments.  Do so for at least 6 months, or a year, if possible.  Even then, there is some risk, but after a year of making payments he would have a "good faith paper trail."

The lesson here – if you find yourself in significant debt, think very carefully about making any significant financial moves.  Seek professional counsel.  Several times a month, I meet with people for a bankruptcy consultation and we end up deciding that bankruptcy is not the right move right now.  More importantly, I advise these folks what not to do and how to avoid making a bad situation worse.  Quite frankly, these type of clients get real value out of their consultations and I encourage anyone who thinks that there is a 1% chance of bankruptcy to spend an hour with a bankruptcy lawyer.

Technorati Tags: chapter 7 bankruptcy, balance transfers, cash advances, Section 523, objections to dischargeability of debt

April – cash advance of about 4-6gs’
May – cash advance of about $500
July – filed Bk 13 end of July
Aug – Ch13 341 Meeting
* Trustee objected to my “good-faith,” payback of $250 a month *
The Median Test proved I was not in presumption of abuse and I had negative -$60 disposable income, Schedule I and J proved I had $800
October – Objection to confirmation goes Easter District, state of Virginia Judge
* Judge did not want say yay or nea and wanted me to re-submit another plan, Judge mentioned I was not forced to work 2 jobs, I could quit one and convert to Ch13, or I could resubmit a new plan * It only made sense for me to quit one job than have to payback $800 bucks for the next 5 years *
Oct – I quit one job, converted to Ch7
Nov – Ch7 341 meeting
Now I’m just waiting to discharge (hopefully by January) last day for creditor objections Jan 8, 2007

At the time I was in Ch13, I didn’t hear of any objections from creditors or even a peep about my recent cash advances from April-May. (due to being a gambler) I thought it my Bk would be a big issue. Not a peep about that either. Now that I’ve converted to Ch7 and another 60 day to objection starts over. My concern is what are the chances of objection/adversary’s coming up from creditors. My thoughts are this, I haven’t paid any of them since June/July its been IF you count from MAY until now (DEC) about 6-7 months since my last cash advance (I think its like 180 days one should wait if they’ve had heavy spending on their credit cards – and since mine were cash advances due to gambling – I would think it would be a big issue!)

What are your thoughts?

Thanks, Mickey aka Catchmeifyoucan

Jonathan Ginsberg responds:  Mickey, thanks for the kind words.  To answer your question….my experience has been that most credit card lenders will not object to dischargeability if the total debt owed to that particular creditor is $15,000 or less.  I suspect that the cost of retaining counsel and pursuing smaller claims is too high.  I also think that the more time between your use of the cards, the better.  Here, you have a fairly large cash advance in April, but you do have a good faith payment in May, then a Chapter 13.  You did not say how large your total balances are to any particular lender.

Under the old law, debts that were not dischargeable in a 7 would be dischargeable in a 13.  That has now changed but I have not seen much of a change by the credit card lenders.  Here, because your loans were most likely coded as a Chapter 13, you may slip through the cracks.  This is even more likely if your case was filed in a busy filing district.

If the bankruptcy specialist at the credit card company wakes up, he would see that his company does have leverage to push you into some sort of a payback settlement.  However, if you have not heard anything by now, you may be under the radar.

Technorati Tags: recent credit card use and bankruptcy, dischargeability action, credit card advance, Section 523(a), Chapter 7 discharge

An analysis of this promotion suggests that it is not quite the deal it seems to be.  Firstly, this Dell laptop (which the promotion calls an $850 value) is going for around $400 on eBay (for a new machine).

So, if you take this deal and your balance falls below $3,500 you would be slapped with a $600 charge in addition to whatever interest you had already paid.

Now, if you are very disciplined and you maintained a $3,500 balance at the current 9.9% rate (although the card rate is "variable" with a rate of 3.49% to the Prime Rate on purchases and 11.99% on cash advances, what happens?

According to my amortization calculations 18 months of interest on a $3,500 balance at 9.9% results in a charge of $280.72 of interest.  So the minimum you are paying for this promotion would be $280.72.  Of course the issuer is assuming that you will not be so disciplined and will use the card and build up a balance of more than $3,500.  In a best case scenario, you would save $100 or so from the eBay cost of a new Dell (slightly used models can be had for less) but you would absorb 18 months of risk for delinquency or early payoff charges.  And, of course, in 18 months, your laptop will be worth about $50 if you are lucky.

If you do not pay down your initial $5,000 balance and pay interest on it for 18 months, then your interest cost jumps to $534.12, which, of course, is more than the open market cost of the Dell. 

I must say that this promotion got me to open the direct mail piece, even if this is not a deal I could recommend.  I will keep my eyes open for the first time I see one of these accounts in a bankruptcy that I file for a client.

–Jonathan

Technorati Tags: credit card promotions, balance transfer offers, adjustable interest rates on credit cards

Jonathan Ginsberg responds: Aaron, there are two potential problem areas you may face:

The first arises from Bankruptcy Code Section 523(a), which provides that there is a presumption of non-dischargeability for the following debts:

- consumer debts owed to a single creditor totaling more than $500 for "luxury goods or services" incurred w/in 90 days of filing;
– cash advances totaling $750 within 70 days of filing

My experience has been that under the new law, most credit card lenders will be very quick to file an objection to discharge of debt if your recent debt falls into this category

Secondly, Section 523 also says that debts incurred under "false pretenses" or with a "false representation" may be non-dischargeable.  This means that no matter when the (credit card) debt was incurred, the credit card company can challenge discharge if they can prove that you knew or should have known that you would not be able to pay the debt when you incurred it.

Ever since the October 17, 2005 effective date of the new law, I have seen a steady increase in the number of challenges by credit card companies.  Most of these cases settle because debtors in bankruptcy do not have the funds to pay a lawyer to fight the discharge action.

So, I fall back on the same advice I have been giving my clients for almost 20 years:

1. as a general rule, if the total debt owed to a particular creditor is $15,000 or less, and you are outside the 90 day window of Section 523, your case probably will not hit the radar of the credit card lender
   
   
2. if you can put 6 months between your last use of the card and filing for bankruptcy, your odds improve dramatically
   
   
3. during the time your case is "ageing," you should consider making a regular payment (even if it is $15 or $20 per month).  Even this small payment shows good faith and may delay the filing of a collection lawsuit.  And if you should come into money and want to pay off the debt your account will not be in "non-payment" status.

–Jonathan 

Technorati Tags: Section 523, credit card debt, discharge complaint, non-dischargeability, Bankruptcy Code