Should I settle some debts before bankruptcy

23 Feb Should I settle some debts before bankruptcy

The client planned to file bankruptcy. Two of his creditors were willing to settle the debt for a substantial discount, my client reported.

Could he accept a reduced payoff before he filed bankruptcy?

There is no bar to compromising with creditors before a bankruptcy filing.

Debtors under California state law are free to pay one creditor over another. The Bankruptcy Code’s preference statute impacts the recipient of a pre petition payment, not the debtor who made the payment. The debtor does nothing wrong by paying one creditor over another. It is the creditor who may have to give a preference back to the bankruptcy trustee. So, from a legal point of view, the client was good to go.

But debt settlement has significant issues. I asked the client if he had he considered the tax impact of the settlement? The amount of the discounted debt will be reported to the IRS as income. (It may not result in a tax due, depending on other issues, including whether the debtor was “solvent” for purposes of the IRS analysis.) The impact on the credit report was not going to improve his post bankruptcy score.

But, more importantly, what was the point of settling a debt before bankruptcy?

Settlement, in my view, is useful only if it allows the debtor to avoid bankruptcy. And my experience in achieving a meaningful settlement with all of a client’s creditors is dismal: some creditor with a big claim is always a hold out.

My advice: find a better use for the thousands the settlement called for. Fund an IRA, repair your car, buy health insurance. There are any number of ways those funds could be a step toward a more stable life after the bankruptcy.

If you are going to take the bankruptcy plunge, horde your cash. Use it to buy things that are useful in your post bankruptcy life.

San Francisco Bay Area Bankruptcy SpecialistCathy Moran helps individuals and small businesses in Silicon Valley with their bankruptcy issues . She can often be found on Google+ and on Consumer Ledger, where she shares information about consumer protection issues and personal finance.

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Cathy Moran, Esq.

I'm a certified specialist in bankruptcy law (California State Bar Board of Legal Specialization) practicing in the San Francisco Bay Area for more than 30 years. In addition to practicing bankruptcy law, I train new practitioners at Bankruptcy Mastery.
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