26 Mar Credit Cards and Bankruptcy: Beware Recent Use
Most credit card debt can be wiped out in bankruptcy. The most common way to lose that right is for a lender to prove they were defrauded. Only rarely do folks intentionally charge up a credit card without having some intention of eventually repaying it and they are even less likely to confess it in court. So judges have to look for hints — “badges,” if you will — of fraud in behavior.
A common “badge” for fraud is substantial charges on the eve of a bankruptcy filing. Particularly if the charges occur after you first consulted with a bankruptcy lawyer. That seems pretty obvious, doesn’t it? If you talked to the lawyer on Tuesday, run up a lot of debt on Wednesday, and file a case to wipe out the debt on Friday, you’d probably call that fraud also.
It’s usually not that simple. Take, for example, a typical case last year in Ohio. A couple who were preparing for divorce filed a Chapter 7 case together. The wife had transferred almost $18,000 onto her new Chase credit card and made some retail charges. Only 82 days elapsed from opening the account to the actual bankruptcy filing. And some retail charges actually occurred after a (divorce) lawyer suggested bankruptcy as an option to consider.
And recall that bankruptcy law presumes fraud if cash advances over $750 were made during the 70 days, or “luxury” purchases totaling more than $500 during the 90 days, before a case is filed.
So it sounds like a slam-dunk case for Chase, right? Not so fast, said Judge Richard Speer. In the Sixth Circuit, the courts are required to determine what the consumer subjectively intended and therefore whether, deep down, they intended to incur a debt without meaning to pay it back.
Although admittedly a close call, Judge Speer pointed out that the debtor had in fact barely increased her total debt at all. The largest portion of the charges were balance transfers to take advantage of Chase’s offer of 0% financing. He pointed out the nearly universal rule is that a balance transfer is not a cash advance. And in this case the wife indicated she was making these transfers to get her financial house in order to prepare for being on her own after divorce.
And speaking of houses, she was trying hard to sell the family home at the time. They had hoped that the home would bring enough to help pay down debt. Although this did not work out and they had to give up the home in bankruptcy, it was further evidence that she had a plan to pay — not defraud — her creditors.
Finally, she did in fact make payments. The judge pointed out that it is a strong consideration that a person did not intend to defraud a creditor if they had actually been making payments on the allegedly fraudulent debt. When combined with the fact that she did not actually increase her overall debt load and had been taking other actions to try to get her financial house in order, the judge concluded that the evidence was nearly “equally balanced” betwen finding fraud and not, ultimately he was more persuaded with her candor than the “badges” which would otherwise bear more weight.
The critical factor to me is that Judge Speer took a moment to consider the important distinction between a “balance transfer” and a “cash advance.” Just because the credit card treats them the same (by charging higher interest, for example) doesn’t mean the law does. First, the presumption of fraud should not apply. But, more importantly, he noted the meaningful difference in the transactions. A cash advance is an increase in debt at high interest, while a balance transfer is a a refinancing of existing debt — something one typically does only to get a better “deal” on repayment. That is a critical difference which credit card lenders would like judges to ignore.
Although the debtor in this case dodged a bullet, the lessons are many. First and foremost, if you are considering bankruptcy then stop digging the hole deeper! Stop using them and try to live off your existing income, even if that ultimately means you can’t make the credit card payments.
Second, even though Judge Speer was enlightened enough to understand a balance transfer is fundamentally different than new debt, that’s not a license to keep transferring balances around cards to get the best deals. I realize some financial advisers (like Suze Orman) have been known to recommend this. But if the bankruptcy is likely, card kiting like this only begs for trouble.
Think about it: The case Judge Speer dealt with included a lawsuit within the bankruptcy and trial against JPMorgan Chase, with more testimony and, ultimately, more attorney fees for her lawyer and the risk of being responsible not only for the Chase debt but Chase’s lawyer’s fees. No one wants to go through that if they can help it.
And — for the love of Pete! — don’t touch a credit card after you talk to a bankruptcy lawyer. That’s just asking for even more trouble.
Case: In re Brumbaugh, — B.R. –, 2007 WL 5006519 (06-32414) (Bankr. N.D.Ohio 10/3/2007)
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