Bankruptcy Alternative: Do Nothing

Individuals faced with debts that they cannot repay often consider bankruptcy. A bankruptcy filing provides a debtor a fresh start, allowing them get rid of most, if not all, burdensome debts through either total liquidation (Chapter 7) or a repayment plan (Chapter 13). However, a bankruptcy filing leaves damaging and long-term impact on a debtor’s credit rating. For this reason, it’s advisable to consider all available alternatives to determine whether there is a less drastic method of solving financial problems.

Being Judgment-Proof vs. Having Unsecured Debts

If a debtor’s liabilities are primarily reflected in consumer debt, such as credit card debt, and the debtor is judgment-proof (i.e., he or she has no income or assets that can be sought by creditors), it may be an option to simply walk away from the debt and ignore creditor collection efforts. However, if any of the debts are secured by collateral, creditors may be able to repossess the collateral without having to go through a lawsuit. For example, a lender may repossess a car if the owner falls behind on the car payments.

It May Depend on How Much Debt You Have

If the amount if debt is considerable, or the debtor is employed or owns a house, property or other assets, a creditor could file a lawsuit to obtain a money judgment, enabling the creditor to place a lien on the property or garnish the individual’s wages. If the amount is modest, or the debtor has no income or assets, it is more likely that the creditor will simply “charge off” the debt after a certain amount of time, typically six months, and cease collection. The creditor will report the negative information to the credit reporting agencies and the bankruptcy filing will be noted in credit reports.

The creditor may also sell the debt to a collection agency that will continue to try and collect on the debt after the original creditor has written off the debt as the cost of doing business. Collection agencies are known for using threatening and deceitful tactics to try to force a debtor to make payments on the debt, however, there are certain legal protections under the Fair Debt Collection Act that prohibit debt collection harassment and punish those companies that violate the law. (Click here for more information on the Fair Debt Collection Act).

Statute of Limitations on Debt

Eventually, the statute of limitations will run out and the creditor will no longer be able to legally sue to obtain a judgment. It is important to be aware that if a payment is made on a debt after the statute of limitations has expired, that payment resurrects the debt and starts the statute of limitations running again. Therefore, one must be careful not to be pressured into making a payment on a debt after the statute of limitations has expired.

Contact Creditors Directly

Another method of avoiding bankruptcy is to deal with the creditors directly to work out a payment plan. Many creditors would rather work out a payment agreement than pursue a costly lawsuit to recover the debt. If an individual is uncomfortable with contacting the creditor directly, he or she can contact one of the many debt consolidation and credit counseling services that specialize in helping consumers resolve their credit problems.

Some Debts Are Exempt From Collections

Even if the creditor decides to sue and obtains a money judgment, under federal and state law, certain property and income is exempt from collection. Creditors cannot seize, through a court-ordered money judgment or otherwise, the following:

  • Household furniture
  • Clothing
  • Food
  • Personal effects
  • 75 percent of wages
  • Unemployment benefits
  • Social Security payments
  • Public assistance benefits
  • Direct deposits from government-sponsored benefit programs

Depending on the state, additional exemptions may be available. In any event, it is advisable to obtain competent legal advice to explore all alternatives and consequences before deciding whether to file for bankruptcy protection or do nothing.