Managing Risk in Bankruptcy

People ask, how much risk is there in filing bankruptcy? Like many things, the answer depends. Bankruptcy is an expansive legal process that carries risk--outcomes can be anticipated but never guaranteed. However, there are choices one can make before and after filing bankruptcy to control exposure to risk. A few kinds of risk merit particular discussion.

Fact Risk

There's a certain universe of facts that are relevant to a bankruptcy case and a bankruptcy petition. The expectation of how a case will proceed is based on the debtor's attorney's understanding of this set of facts, which is tied closely to the debtor's own understanding of these same facts. If these facts are not as they appear, the case will not progress in the same way as anticipated. For example, the nature of or value of an asset is an important fact in a bankruptcy case. If this fact is not understood correctly, the asset might unexpectedly need to be sold in a bankruptcy proceeding. In some situations, the petition and schedules would be objectively wrong, which is itself detrimental to the bankruptcy case.

Fact-based risk is the easiest to control. If the debtor and his or her attorney get the facts completely correct, the risk is largely confined to being unable to prove the facts if later challenged. Cooperation between the debtor and debtor's attorney is essential to getting the facts right. The debtor's attorney must be diligent in inquiring about relevant aspects of the debtor's finances, and the debtor must be forthcoming with information. At times, facts might be uniquely in the control of a creditor or adverse party, which might result in a contested matter in the bankruptcy case.

Sometimes it is sensible to accept factual risk. For example, if the possibility of an appraisal is anticipated but not certain, one might choose to wait until the appraisal is actually required before ordering it. There's a risk that the factual estimate of value might proved to be incorrect.

Legal Risk

Bankruptcy law is not entirely settled. There are aspects of many provisions of the bankruptcy code where attorneys disagree on what the law requires or permits. When a debtor files a bankruptcy petition, the anticipated outcomes are based on a particular understanding of how the bankruptcy law applies to the facts of the case. The law might turn out to be different. Sometimes, the difference is due to the debtor being unsuccessful in convincing the local bankruptcy judge on a point of law. Other times, a locally accepted legal rule might be unseated by a higher court decision.

Going into a bankruptcy, the debtor's attorney should be able to advise the debtor of how well-settled are the particular provisions of law the debtor's desired outcomes depend upon. Important too is what happens if the alternative legal position wins out. By communicating in this area, the debtor's attorney learns how much legal risk a debtor is willing to accept for possibly better outcomes, and the debtor does not get unrealistic expectations about outcomes. Sometimes, when the debtor's circumstances are similar to a typical consumer debtor, legal risk can be minimized as fewer unusual legal issues present themselves.

Implementation Risk

Almost entirely the realm of reorganization bankruptcy such as chapter 13, implementation risk is associated with the likelihood the debtor will actually be able to perform the plan proposed. A successful chapter 13 plan requires several future events to occur in a favorable way to the debtor. These include future income, future expenses, and creditor claim activity. A plan based on wages from a job is exposed to risk that the job is lost and the plan payments are too much to pay. These events that sink chapter 13 plans are largely outside the control of the debtor. Nevertheless, the debtor can consider the risks going into the plan, and if particular concerns exist, could propose a more conservative plan that releases more property or spreads payments out further. Part of managing implementation risk is being prepared to respond, including objecting to creditor claims, seeking plan modification, or even moving for a hardship discharge.