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Columbia - Lexington Bankruptcy Lawyer

The Ethics of Bankruptcy

By Columbia – Lexington Bankruptcy Attorney Lex Rogerson

integrity - optimizedBankruptcy courts expect debtors to act in good faith, which means being honest, cooperative, and fair.

A while back we discussed the moral obligation to pay debts and its effect on the decision to file. In short, we concluded that those who can pay debts should do so, but that if that’s not possible, filing bankruptcy is often a reasonable decision. Now let’s look at what a conscientious debtor should do once the decision is made to file.

Honesty and good faith

The bankruptcy code is chock full of requirements, direct and indirect, that the debtor act in good faith.

  • To get a chapter 13 plan confirmed, both the plan and the overall bankruptcy case must have been filed in good faith.
  • A chapter 7 case may be dismissed if the debtor acted in bad faith.
  • And if the debtor has been dismissed from bankruptcy in the last year, filing another bankruptcy case gives rise to a presumption of bad faith and, if not rebutted, limit the automatic stay that protects debtors against collection efforts.

In South Carolina and its sister states of the Fourth Circuit, a court determines good faith based not on a single indicator but rather on the totality of the circumstances. One of the most important factors is the honesty of the debtor in disclosing all the required financial information. In one notable case in this district, where the debtor was attempting to litigate an issue of precedent regarding social security benefits, he damaged his chances of success by failing to disclose all his income. Famous people have served time for hiding assets, including former major league all-star Lenny Dykstra and former University of South Carolina president James Holderman; retired NFL pro bowl Rick Sanford escaped prison but not a federal criminal conviction.

When my clients balk at discussing assets or transfers that can affect their bankruptcy cases, Holderman and Sanford provide important object lessons. I find most people will be entirely forthcoming if they understand that fudging a little is not only unacceptable but dangerous. The only workable approach is to disclose the whole truth to your lawyer so you can directly confront any problems before filing — not to dodge problems that can become devastating when they come to light too late.

Cooperation

The bankruptcy code requires every debtor to appear for questioning at a meeting of creditors and to cooperate with the trustee appointed for the case. Each debtor is required to provide the trustee with his most recent federal tax return and to file the most recent two months of pay stubs.  Trustees have the power to demand additional documents relating to the debtor’s. Failing to cooperate with trustee requests can mean no debts are discharged, and failing to provide tax returns or pay stubs timely can lead to automatic dismissal of the case.

These requirements (and a few others) represent the bare minimum in cooperation. Smart debtors and their lawyers will respond to trustee requests fully and rapidly — the same day or the next day if at all possible — with full explanations and documentation. Prompt cooperation signals that you have nothing to hide, and making a trustee’s job easier pays big dividends in the long run.

Fairness

Other factors affecting good faith include the debtor’s pre-filing conflict and the proposed treatment of creditors. Now, no creditor likes having its debt discharged, but bankruptcy courts understand that insolvency means creditors generally lose out. Courts are much less understanding when the debtor treats creditors poorly without justification.

The classic example — much touted by financial institutions but rare in practice — is incurring substantial new unsecured debt shortly before filing bankruptcy.  This can lead to the debt being declared fraudulent and not being discharged.  In an extreme case, the debtor could be prevented from discharging any debts.

Similarly, a debtor might finance a vehicle in a high interest loan (say, 12%) shortly before filing Chapter 13 and then propose to pay the car loan through the plan at the court’s standard rate (in the District of South Carolina, that’s currently 5.25%). The principal balance of the loan doesn’t change, but the lender loses the benefit if its interest bargain. Depending on the specific timing, such treatment can lead the court to find bad faith and deny confirmation.

The line between aggressive bankruptcy strategy and bad faith is not an easy one to draw, but it is an important one. It is a question of common sense, and it’s mostly a matter of degree. To use the old lawyer’s cliché, pigs get fed, but hogs get eaten.

The take-away

Filing bankruptcy inherently means altering the debtor’s legal obligations. Bankruptcy ethics don’t require that every creditor be paid in full. They do require that the debtor play by the rules, and the most important rule is honesty at every stage.

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