Bankruptcy Requires Good Faith
The main purpose of bankruptcy is to give debtors a fresh start from oppressive debt by either liquidating the debtor's assets or by allowing the debtor to pay at least some of the debt over time. It also forces all creditors to deal with the debtor through the bankruptcy court, so that no one creditor prevails at the expense of other creditors and most of the unsecured creditors are paid an equal portion of their debt, whatever that may be.
However, the bankruptcy process can only work if the debtor is honest, because much of the process depends on the debtor's disclosure of financial information — his income, expenses, and assets. Furthermore, bankruptcy should not be permitted to be used as a means for the debtor to get money without intending to repay it, for if it did, it would greatly restrict the availability of credit. It would become a legal form of theft.
Hence, bankruptcy depends heavily on the debtor's good faith. In bankruptcy, good faith is the debtor's honest intention of using the bankruptcy process to get a fresh start from oppressive debts incurred either because of circumstances beyond his control, such as medical debts, the loss of employment, or decreased business, or because the debtor did not manage his finances well. In other words, the debtor did not borrow any money that he did not intend to repay.
Since good faith is required for bankruptcy to work as intended, judges punish the lack of good faith by either dismissing the bankruptcy case without giving the debtor a discharge and by lifting the automatic stay that prevented creditors from confiscating property or income to pay off their debts.
Although good faith is not defined in the bankruptcy code, judges have, over the years, developed criteria to determine whether the debtor has good faith. However, good faith must be determined by the totality of the circumstances.
- Was the debtor honest?
- Were financial disclosures complete and accurate?
- Did the debtor fill out credit applications with complete and accurate information, or did he attempt to mislead or defraud creditors, such as by overstating his income?
- Were the debts incurred because of unfortunate circumstances or because of irresponsible or outright fraudulent conduct?
- How much effort has the debtor expended in paying his debt or in treating his creditors fairly?
- Did the debtor incur debt for devious or dishonest reasons, such as incurring a large debt shortly before filing for bankruptcy?
- Was the debtor abusing the bankruptcy process?
- Did the debtor try to hide assets or transfer assets for his benefit or for the benefit of those close to him, such as family or friends?
- Did the debtor file for bankruptcy for reasons other than insolvency, such as trying to get out of a particular debt or a contract? For example, it is a sign of bad faith when a performer files for Chapter 11 or 13 to get out of a performance contract because she was offered a better contract afterwards.
- How often has the debtor filed for bankruptcy and how long has it been between filings? Frequent filers are usually using the bankruptcy process for their own gain.
Lack of Good Faith
A lack of good faith in a bankruptcy case can result in 3 major actions. The case may be dismissed, in which case, the debtor gets no discharge and all his debts remain as before. And since the automatic stay will be lifted, the creditors can proceed with their claims against the debtor.
A lack of good faith may also prevent the confirmation of a payment plan, that is required in the rehabilitative bankruptcies — Chapters 11, 12, and 13. Without confirmation of a payment plan, the bankruptcy cannot proceed and the debtor cannot receive a discharge. If the debtor cannot revise the plan so that it is acceptable to the court, trustee, or creditors, then the case will be dismissed and the automatic stay lifted.
The bankruptcy case may also be converted to another chapter if it becomes apparent that the debtor could be paying more to his creditors or if the debtor selected a particular chapter to discharge a large debt or to get out of a particular contract even though he is still able to fulfill that contract.
Bankruptcy Abuse Prevention and Consumer Protection Act (BAPCPA)
A major revision of the bankruptcy law — the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 (BAPCPA) — added several provisions that attempts to limit acts of bad faith.
Means test for Chapter 7 and Chapter 13. The means test was added to the bankruptcy code to force debtors into Chapter 13 if they have significant income. Previously, many high-income debtors were filing for Chapter 7, even though they could easily have paid more to their creditors. Furthermore, if their income is above the state median, then their payment plan must be for 5 years rather than 3, providing a greater return for unsecured creditors.
Mandatory credit counseling and debtor education. To get a discharge, the debtor is required to take credit counseling courses before filing for bankruptcy, then a financial management course that can be taken during the bankruptcy. Both the credit counseling course and the personal financial management course must be provided by agencies approved by the United States Trustee.
910-day limit on auto lien-stripping. If the debtor bought a car with a secured loan within 910 days of filing for bankruptcy, then the auto lender could retain its lien for the full amount of the debt rather than just for what the vehicle is worth.
Limited $146,450 homestead exemption. Some debtors moved to states with unlimited homestead exemptions, such as Texas and Florida. Now, the homestead exemption is limited to $146,450 if the home was acquired within 1,215 days before the filing date.
Automatic stay limited for serial filings. The automatic stay is limited to 30 days for a 2nd filing and does not take effect at all for debtors who have filed more than 2 bankruptcies in the past unless the debtor can convince the judge otherwise.
Minimum time between discharges. A debtor cannot receive a discharge from any chapter of bankruptcy within 4 years of a previous bankruptcy filing date that resulted in a discharge. A debtor may not receive a Chapter 7 discharge within 8 years of the bankruptcy filing date of a previous Chapter 7 discharge or within 6 years of the filing date that resulted in a Chapter 13 discharge. If, however, the debtor paid 100% of his unsecured claims in the previous Chapter 13 case or, through a good faith effort, paid at least 70% of such claims in the previous case, then the 6-year rule does not apply.
Limitation on discharges for recent unsecured debts. If the debtor bought more than $500 on credit from any 1 creditor within 90 days of filing or received a cash advance within 70 days of filing, then these debts will not be dischargeable.
Attorney verification of the bankruptcy petition. If the bankruptcy petitioner is represented by an attorney, then the attorney must sign the petition, indicating that she reviewed the document and has reasonable grounds for believing that the information is true; otherwise the attorney may be liable for falsehoods or significant omissions.
Student loans are not dischargeable. Previously, only student loans from government agencies were usually not dischargeable; now, even student loans from private lenders are not dischargeable.