Avoid Credit Card Use Prior to Filing Bankruptcy

If you’re thinking of filing bankruptcy in the near future, don’t use your credit cards!  You see, credit card companies used their deep pockets to lobby Congress to add special protections to credit card lenders in the 2005 bankruptcy reform.  The code now provides that any use of a credit card to purchase luxury goods or services within 90 days of filing bankruptcy will be presumed “fraudulent” and therefore nondischargeable in bankruptcy. Why are they fraudulent? Because the creditor will attempt to prove that the debtor had no intention of repaying the debt when he charged the item because he knew he would be filing bankruptcy. What this means is that your older credit card debt will be wiped out, but the newer debt will survive your bankruptcy, and your creditor may sue you later for the amount owed. And while many items are certainly not luxury items, any charges prior to your petition will raise a red-flag with a credit card company, especially if the total balance is over $10,000.

Here’s an example to illustrate the concept of fraudulent credit card use:

Michael is a recently laid-off worker from Atlanta, Georgia who has not been able to land a job due to the economic downturn.  As a result, he can barely afford to pay his basic living expenses and is seeking the help of an Atlanta bankruptcy attorney. Over the past several years, Michael has accumulated around $15,000 of debt on his American Express from normal living expenses.  However, two months before filing bankruptcy, and without disclosing the purchase to his attorney, Michael charged $5,000 to take an Alaskan Cruise.  I’m sure the glaciers were beautiful.  After Michael files bankruptcy, the court will notify American Express because they will be listed as a creditor on Michael’s bankrupcty schedules (the paperwork your lawyer will file with the court).  When AmEx sees that Michael charged an Alaskan Cruise a mere 60 days prior to filing, they will file a law suit in bankruptcy court called an “adversary proceeding” to object to the dischargeability of their claim in bankruptcy.  Again, if AmEx were to prevail in this law suit, you will be on the hook after bankruptcy for the entire amount deemed to be a fraudulent charge.

It is important to understand that only the $5,000 charged for the Alaskan Cruise will survive your bankruptcy.  If Michael has $50,000 of other unsecured debt, it will still be discharged.

The good news is that suits like this rarely go to trial, and most credit card companies are not going to sue you for charging a few thousand dollars worth of living expenses within 90 days of filing since only luxury items and services are presumed to be fraudulent charges.

The reason I advise clients not to use credit cards for 90 days unless it is an absolute emergency is that there is always a chance the card issuer will sue you, and litigation is not cheap.  A bankruptcy attorney’s flat-fee charges will almost never include litigation of this nature, so by simply avoiding the use of credit cards, you can rest assured that your case will proceed smoothly.

One last point: DO NOT transfer a balance from one card to another prior to filing bankruptcy.  A balance transfer is treated as a cash advance, which is also presumed to be fraudulent within 90 days of your petition date.  Don’t worry.  In most cases, all of your credit card debt will be wiped out anyways, so there really is no point to interest rate shop during this time of your life.