5 Things to Avoid Before You File Bankruptcy

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Filing for bankruptcy is already a formidable task, so you’ll want to do everything you can to avoid shooting yourself in the foot and making the process that much harder. Unfortunately, some actions that seem perfectly reasonable, and even prudent, can actually land you in even more trouble. In worst-case scenarios, the court can dismiss your case, leaving you responsible for paying your debts. (See also: How to Know When It's Time for Bankruptcy)

If bankruptcy is on the horizon — and you're certain it's unavoidable — here are five things you definitely should not do (even if you think you should).

1. Don't Pay Down Your Debt

Although it may seem counterintuitive, you should not make any payments toward your debts once you decide to file bankruptcy. The reasoning for this is two-fold.

First, bankruptcy rules forbid sending more than $600 in "preferential payments" to any one creditor in the three months before you file bankruptcy. This means that if you keep making payments on your credit card in hopes of being able to keep it post-bankruptcy, the court will seize the money from the company and disperse it among all your creditors. The law is even stricter with payments made to relatives, friends, and business associates. The court can go back up to one year and seize these payments.

Second, continuing to pay debts once you intend to file bankruptcy usually doesn’t help your case or ensure you’ll be able retain the credit line once your bankruptcy is discharged. In most cases, creditors will close your account once you file bankruptcy, regardless of your continued payments. Plus, those debts are likely to be discharged anyway, so making payments is really just throwing money away.

The one caveat to this rule is that you should continue to pay on secured debts such as your mortgage or car note if you intend on keeping the property and reaffirming, or continuing to pay, the debt once your bankruptcy is over.

2. Don't Cash Out Your Retirement Accounts

Although using your retirement accounts may seem like a good idea, there are a couple of reasons why it’s not.

First off, as noted, making payments generally doesn’t help your bankruptcy case. Plus, retirement funds are untouchable in bankruptcy, so the court can’t take them to pay your creditors. However, any money you take out of your retirement accounts to pay down your debts in the three months before you file bankruptcy is still subject to preferential payment rules. This means that the money may be taken back and spread out to all your creditors equally, defeating the purpose of making the payments and leaving you with an unnecessary hole in your nest egg.

3. Don't Use Your Credit Cards

If you use your credit cards to make more than $500 in purchases within three months of filing for bankruptcy or take out cash advances totaling $750 within 70 days of filing, you’ll have to prove that the funds were used for goods or services that are necessary to maintain your household. This includes payments for gas, groceries, utility bills, and medical fees, but not things like new electronics, vacations, expensive clothes, or fancy dinners out. If the court decides that the purchases were for nonessential expenses and luxuries, it will assume that you continued to utilize your credit with no intention of repayment and leave you responsible for that portion of the debt.

If the purchases are made more than three months before you file, the burden of proof falls on the creditor to prove that funds were used on nonessentials with no intention to repay. It’s not enough to show that you knew you couldn’t pay. They have to prove that you never had any plans to pay when you made the purchases. This may be difficult, but it’s not impossible, so it’s best to err on the side of caution and avoid using your cards as soon as you make the decision to file bankruptcy.

4. Don't Give Away Your Possessions

You are required to disclose all assets, such as real estate, vehicles, investments, cash, and other valuables that you sold or gave away within four years of filing.

There’s no problem if you transferred the property to an independent party. However, if the assets end up in the hands of friends or relatives, the bankruptcy trustee may suspect that you’re trying to hide the items to avoid having them seized by the court to repay your creditors and order the new owner to return them to you. Although most people don’t have to worry about the court undoing a transfer within the past four years, the court will get suspicious if it seems like you have been steadily giving stuff away over the past few years.

5. Don't Lie to Your Attorney

Unless you’re filing pro se, or without a lawyer, it’s your attorney’s job to make sure you receive fair treatment from creditors and the court. He’s also responsible for making sure that all the t’s are crossed and i’s are dotted on your bankruptcy petition so you can avoid legal trouble. However, failing to disclose any information about your income, assets, or debts to your lawyer can hinder his ability to help you if the information comes up in the course of the case.

You must be completely upfront with your attorney, even if you think your situation is embarrassing. It’s even more important to be honest if you think you did something that goes against the bankruptcy rules, so your lawyer can advise you on the best course of action.

Have you filed for bankruptcy? What was your experience like? Was the process easier — or more difficult — than you expected?

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