People are frequently concerned about the effect a bankruptcy will have on their credit scores.  However, a bankruptcy on a credit report is probably not as bad as most people assume.  It may seem counter-intuitive, but in many situations, a bankruptcy can actually improve a person’s credit.  This is because those in need of bankruptcy probably have bad credit already, which is the reason they are filing to begin with.  If someone has more debt that they can afford to pay, it is going to take a toll on their credit score.  They will have high debt to income ratios, and inevitably will have late payments reflected on their credit reports, which are all detrimental to a person’s credit profile.  A bankruptcy can wipe out all of the bad debt that is causing all of these negative factors to appear on a person’s credit report.  So, while a bankruptcy might not be a great thing to see on a person’s credit, it can be better than the alternative.  Not only that, but the fresh start that a person will have after a bankruptcy can allow someone to start building a positive credit profile a lot faster than if they tried to get themselves out of the debt without a bankruptcy.  A relevant article on this subject was recently written by Jean Chatzky on the NY Daily News titled “There is life after bankruptcy:  Credit could thaw in 18-24 months.”

The economy has been in a downturn for quite some time now.  For the past couple of years, the poor shape of our national market has continuously made the news, to a tiring degree.  With the arrival of 2010, projections are being made for this year, and it’s also time to reflect back on the numbers of 2009.  It should come as absolutely no surprise the number of Indiana bankruptcies in 2009 rose again over the prior year, as did bankruptcies in the rest of the country at a rate of 32%.  In 2009, over 1.4 million bankruptcies were filed across the United States.  Perhaps more surprising is that it is not a record, but only the 7th highest number of filings in a given year, behind the years 1998 and 2001-2005–years in which the national economy appeared to be booming (of course, the 2005 bankruptcy reform mostly likely has much to do with the higher rate of filings in the years preceding).  For the complete story, see this article written by Mike Baker of the Associated Press. 

It seems commonplace that anytime a new government program is enacted, scammers are ready to use the public’s unfamiliarity of the program as a way to extort money from them.  The United States Trustee Program, a division of the Department of Justice which is responsible for overseeing the public’s compliance with bankruptcy laws, has revealed a new tactic that scammers have used in light of the recent government programs that have been established to help homeowners obtain affordable home loan modifications.  The scam works something like this:

First, the scammer will visit a local church or other public forum, and get permission to speak.  The scammer will then lure the audience in, telling them that he can help them lower their mortgage payments with the new government program.

Next, once the scammer has lured a homeowner in, he will then obtain all the information about the homeowner and the home loan that is necessary to pull off the scam.  At that point, he will tell the homeowner to pay him directly, rather than the mortgage company, at a reduced monthly rate.  The scammer promises that he will solve the homeowner’s problems, and that the homeowner will not have to hear from the mortgage company anymore.

In the meantime, the scammer will use the loan information and the homeowner’s identification (that he readily collected from the homeowner) in order to contact the lender and update contact information so that the scammer, rather than the homeowner, is receiving all communication from the mortgage company.

While the scammer is collecting money from the homeowner, the homeowner is under the impression that those payments are going to the mortgage company.  Of course, the scammer is in actuality pocketing this money, and not attempting any modification with the mortgage company.  However, because all communications are now being sent to the scammer rather than the homeowner, the homeowner believes that everything is fine since the mortgage company has seemingly not sent any correspondence.

Because a bankruptcy halts foreclosure actions, the scammer, using the homeowner’s stolen identity, will file bankruptcy in the homeowner’s name.  The homeowner will not have any clue that this has happened.  The scammer will never appear at the courthouse as required in a bankruptcy, so the bankruptcy will get dismissed.  However, by filing the bankruptcy, the scammer has bought time, and thus is able to continue collecting from the homeowner for a longer period of time.  The scammer will continue to file bankruptcies in the homeowner’s name, and they will continue to get dismissed, until somebody catches on.  Predictably, by then, the scammer will use his best efforts to disappear.

The United States Trustee is investigating around 180 such cases at the moment, over 30 of which are in the Indiana region.  Particularly troubling is that in many such instances, the homeowners were not even behind on their mortgages at the time they were approached by the scammer, but were living month-to-month and were hoping for some relief.  By the time the scammer pulled his tricks, however, they were too far behind to save their house.

With this said, it is important that homeowners be skeptical of anyone coming to them claiming to be able to help.  Instead, if homeowners are looking for help, they should seek it out at established businesses or with their mortgage lender themselves.  If they feel that they may have been part of a similar scheme, they should immediately contact the authorities and their mortgage lender.

Once in a while, someone will call our office wanting to speak to a lawyer about a “medical bankruptcy.”  Under the Bankruptcy Code, there is no such thing as a special medical bankruptcy.  A debtor cannot only “claim bankruptcy” on medical debts but maintain their credit cards as usual.  The essential reason for this is that the bankruptcy laws do not allow certain creditors of the same class (for instance here, general unsecured creditors) to get better treatment than others of the same class.  In the eyes of the Bankruptcy Code, all of these creditors must be treated equally, and no such favoritism amongst creditors can be shown.  When people use the term “medical bankruptcy,” what they are referring to is a bankruptcy that was primarily caused by medical debts.  For instance, a 2007 study by the American Journal of Medicine showed that over 60% of bankruptcies  studied were filed primarily due to debt arising from sickness and medical bills (AJM, Volume 122, Issue 8, Pages 741-746 (August 2009)).

The health care reform debate has been a current hot topic for the Obama Administration.  It will be interesting to see its effects on bankruptcy filings.  Based on the current bankruptcy filings related to medical debts, bankruptcy can be thought of roughly as a form of secondary insurance, or sometimes a primary insurance, for those incurring mounting hospital bills.  For these individuals, bankruptcy may be the only way to ensure that they will not drown financially from their health care needs.  The proposed health care reform promises lower costs and better availability of treatment for millions of Americans.  Meanwhile, a bankruptcy may help individuals lower/eliminate health care costs, but it does nothing in regards to availability of treatment.  In fact, due to the negative externalities it generates, it arguably is detrimental to available treatment for many Americans.  Thus, health care reform can provide a great additional benefit in this respect.  However, the larger debate in many people’s minds is whether the Constitution would suggest an implied fundamental right to reasonable health needs, or whether this dubbed “socialized medicine” stretches beyond what our system of capitalism should provide.  Whatever happens, there is no doubt that bankruptcy is a well-established tool for those most impacted by uncontrollable medical debts.

Recent news has made mention of the idea that bankruptcy is no longer a stigma of failure in our society.  However, does bankruptcy benefit the larger market?  Here are some thoughts regarding the fundamental purpose of bankruptcy and the role it has continuously played in our structured economy.

Overall, having bankruptcy in our system of laws is arguably a good thing.  Federal laws permitting people to file bankruptcy have existed since America’s early history.  The availability of bankruptcy is partly to credit for the entrepreneurial spirit and past successes of America’s economy.  For instance, without the bottom line option of bankruptcy, the personal financial risks of entrepreneurs would increase dramatically, discouraging them from bringing their ideas to the market because the risk of failure could leave them forever indebted.  Although incorporating a business is one method for limiting an entrepreneur’s personal liability in a business venture, the reality is that most lenders require a young corporation’s owners to personally guarantee any loans of the corporation, thus limiting the usefulness of a corporate shield on the extension of credit.  It is bankruptcy then that helps reduce the risk of an entrepreneur’s survival, and in turn ultimately is a large factor in promoting the beneficial competitive forces in our economy which produce innovative products and discourages monopolization.

In essence, the existence of bankruptcy has structured our economy in such a way that helps create a fair trade-off between lenders and consumers.  On one hand, lenders know that extending credit to a consumer will be profitable, but sinking them in debt runs the risk of the consumer being forced to consider bankruptcy.  As a result, the existence of bankruptcy helps prevent the over-extension of credit by unscrupulous lenders, or at least forces them to share in the consequences of doing so.  In fact, some speculate that the new bankruptcy laws passed in 2005, which made some sweeping changes to the bankruptcy system, are partially to blame for the economic downfall which sharply emerged in 2008—the reason being that creditors began extending even riskier credit with the false belief that consumers would have difficulty qualifying for bankruptcy under the 2005 changes.  On the other hand, consumers can be encouraged to stimulate the economy by making purchases without the fear that one honest but regretful purchase will leave them indebted beyond their means for their entire lives.  Without this option, our economy would likely move much more slowly.

It is important to keep in mind that most debts that are eliminated in a bankruptcy are the result of lenders voluntarily offering credit cards or loaning money to a consumer in the hopes of eventually making a profit from them.  Lenders are aware, and in fact expect, that a certain amount of the credit cards and loans will default and that a certain amount of them will become part of a bankruptcy.  Yet, these lenders still determine that it is more profitable to offer the credit cards or loans than to not offer them at all.  In a good market, this can be viewed as a sound business strategy, but in a bad market, this business model appears to be little more than a gamble.  When lenders gamble with the extension of credit, of course they should expect that many of these consumers will wind up forced with the option of bankruptcy.

Other debts are not always voluntarily entered into by the creditor, most notably medical bills.  Instead, these debts ultimately get externalized to society as a whole.  This in turn causes those who can afford to pay for their hospital bills to be charged more, almost always by means of increased health insurance costs.  Even without bankruptcy, many non-insured medical debts would never be paid.  Obviously, the controversy of health care costs is a heated and complex issue in this country.  However, as our laws have long permitted medical bills to be discharged in bankruptcy, it is clear that our nation has determined that society is better off at the end of the day by permitting people to get a fresh start away from these overwhelming debts rather than the alternative possibility.

The current state of the economy has led to an overall hardship in almost every industry, including for debt collectors.  Debt collectors are entities trying to collect the debts for an original creditor.  For instance, since a hospital specializes in medical services, it may hire a third-party debt collector to attempt to collect unpaid hospital bills from consumers.  This is an important distinction, because the practices of such third-party debt collectors must not be out of line with the federal laws of the Fair Debt Collection Practices Act (FDCPA).  The FDCPA creates statutory liability for debt collectors who use abusive tactics in their attempts to collect debts.  As can be anticipated, in a rough economy, collecting debts can become especially difficult.  With the pressure to collect debts remaining, debt collectors may use increasingly aggressive tactics, which may cross the line of acceptable conduct under the FDCPA.  Recent lawsuit filings concerning debt collector abuses in Indiana’s federal district courts seem to support this predictable trend of greater violations.  As released in Indiana Lawyer, vol. 20, No. 3, “Abusive Tactics Increase,” in the first few months of 2009, there have already been 28 cases filed regarding the FDCPA, in sharp contrast to the 12 that were filed during all of 2008.

It is important that consumers are aware of the protections they receive from the FDCPA.  Of course, many individuals would probably assume that if they could not afford to pay their debts, then they would not be able to afford an attorney to help stop the abusive practices.  However, where FDCPA violations exist, it is the debt collectors that will be forced to cover the plaintiff’s attorney’s fees and costs.  Some individuals are under the impression that bankruptcy is their only option to stop the harassing activity from a particular debt collector, when in reality avoiding bankruptcy and filing a claim under the Fair Debt Collection Practices Act may the appropriate solution.