Don't borrow from Peter to pay Paul, especially if you're planning to file for Bankruptcy!

Borrowing money leading up to a bankruptcy can cause multiple problems.

First, the debt for those funds could be non-dischargeable, meaning you will still owe it after the bankruptcy.  An example of how this could arise, was described in a previous post: Should I Pay My Student Loan with a Credit Card?  Debts such as student loans, certain judgments for personal injury resulting from gross negligence and or drunk driving and debts obtained by fraud cannot be discharged under the bankruptcy code.  If you borrow from another source, such as a credit card, to pay that loan then the new debt will be non-disagreeableness because the funds were obtained with the intention of filing bankruptcy and furthermore, the new loan can be treated the same as the original debt.

This means that even if the credit card company doesn't object to the discharge, they still might be able to pursue you after the discharge, just like a student loan company could (although best practice for the credit card company would be to object prior to the discharge).

Second, if you used these borrowed funds to pay another debt, those funds might be subject to taking by the bankruptcy court as a preference (a debt paid to the disadvantage of other creditors).  If that debt was a non-dischargeable debt, then you may still end up owing that debt after the bankruptcy, and the trustee could use those funds to pay other debts.

Third, and even worse, if the bankruptcy court found that you were attempting to commit a fraud upon the Court by moving this debt, the Court could deny your discharge altogether.

Finally, you could even be subject to criminal liability if the borrowing is determined to be a fraud, meaning you never intended to pay it back.  Fraud is a state crime and bankruptcy fraud is a federal crime.  

FAQ #13: What debts will bankruptcy not erase?

Even if you receive a general discharge, some particular debts are not discharged under the law. You may still be responsible for most taxes and student loans; domestic support and divorce settlement obligations; most fines, penalties, forfeitures and criminal restitution obligations; debts which are not properly listed in your bankruptcy filing; and debts for death or personal injury caused by operating a motor vehicle, vessel or aircraft while intoxicated on alcohol or drugs. Debts incurred to pay non-dischargeable debts will themselves be non-dischargeable as well. In simpler terms this means that you cannot, for instance, use a credit card to pay your student loans and then discharge the credit card.

Also, if a creditor can prove that a debt arose from fraud, breach of fiduciary duty, or theft, or from a willful and malicious injury, the bankruptcy court may determine that the debt is not discharged.

What is Bankruptcy Fraud, and How Can I Avoid Becoming Lenny Dykstra?

Former major league slugger and touted stock picking guru Lenny Dykstra fell on hard financial times after a number of his business ventures began to fail. Like many entrepreneurs in the later half of the past decade, Lenny filed for bankruptcy.

For many individuals, filing bankruptcy allows for a "new start." Unfortunately for the former Met and Phillie, the trouble that plagued him during much of his playing and post-playing career also followed him into bankruptcy. The center fielder nicknamed "Nails" for his tough style of play was arrested on charges of bankruptcy fraud after his bankruptcy trustee's claim that Dykstra improperly removed, sold, and destroyed property that was part of his bankruptcy estate.

Bankruptcy fraud is when a debtor falsely claims bankruptcy, attempts to conceal his assets, launches petition mills (schemes that claim to help financially-strapped tenants from eviction), or files multiple claims in different states. It is a felony, and carries a sentence of up to $250,000 and/or five years in prison.

The lesson here is... well... don't do that. It is important to understand that bankruptcy trustees can, and often do, investigate into the truth of someone's bankruptcy petitions. If they find something that they believe was deceitful, your bankruptcy petition could be denied, and you could face criminal charges. Be sure to disclose everything to your bankruptcy attorney.

If you would like more information about how to best prepare for bankruptcy, contact Attorney Matthew Trask or call 508.655.5980 to schedule a one-hour consultation.