What is Bad Faith When it Comes to Bankruptcy?

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Question Mark (Photo credit: auntiepauline)

What is bad faith when it comes to bankruptcy?

A blogger posting his personal bankruptcy story recently on a bankruptcy forum website asked this very question. He blogged: “I have an ownership interest in an entity which owns real property. It pays me about twenty five hundred dollars a quarter. I can sell it for about $80 thousand to one of the other partners. If I sell it today, and simply live on it for “normal and expected” expenses, etc., and file a bankruptcy petition when it’s gone, can I anticipate an objection from anyone? Is it bad faith if I don’t pay the credit cards, but use the money to pay my rent, medicines, utilities, things that are just my living expenses?”

This question is a valid question asked by many who face having to file for bankruptcy protection. This particular blogger has been unemployed for two years and has no other assets. He explained in other posts how much he needs the money just to survive.

Unfortunately, determining what is good and bad faith in dealing with any court of law is a gray area at best, and when a challenge is presented, it is usually ultimately determined by a court judge. In bankruptcy cases, a bankruptcy court judge would determine whether a purchase prior to bankruptcy was made in good faith and not preferential treatment of one creditor over the other.

When filing bankruptcy, you are required by bankruptcy law to list all your current creditors and asked to give an account of how you have spent your money the past six months. The bankruptcy court normally can look back a year in trying to determine whether preferential payments have been made to creditors, and they can look back further if they suspect insider preferential payments or fraud.

Every bankruptcy court is given a broad interpretive leeway in determining what is preferential and what payments have been made in good faith transactions. Common sense and bankruptcy laws usually guide the decisions.

In the case of the illustrated blogger above, I would think most bankruptcy trustees, or creditors for that matter, would not question the previous spending of money on every day living expenses like those described. If a trustee or creditor did object, the likelihood of getting a bankruptcy judge to agree to a recall of the money might also be unlikely.

If the blogger is seen as trying to make minimum payments to his credit card creditors or negotiating with them during the time frame he spent the $80,000 living, and he made no large unrealistic purchase of luxury items during this time, I would think a trustee or a creditor, come bankruptcy time, would have a hard time making a case for preferential payment against the debtor.

Again, every case is different when it comes to preferential treatment, and every bankruptcy court and trustee are different too. Determining good and bad faith is a hard thing to do in any court, and the process of doing so can be very expensive.

Ask your bankruptcy lawyer about determining good and bad faith and whether or not a windfall can be spent on certain living expenses before filing. The questions could save you some head aches and expenses in the long run.

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