When Is The Right Time?

Recently, a friend and small business owner asked me: “At what point should someone start considering Bankruptcy?”  This is a difficult question to answer, and it varies greatly depending on the situation.  Nevertheless, as one of the Arizona bankruptcy judges – Judge Case – has stated, “Fundamentally, bankruptcy is a matter of timing.”   So, it is important to establish your timeline as you are feeling overwhelmed by debt.
Bankruptcy is a major step to take, and for most people it has never crossed their mind as an option.  As a result, most people are unfamiliar with what Bankruptcy even really is; let alone whether or not they should consider it.  The current economic conditions have put many people in this rather foreign territory. 
As I explained to my friend, there is no general rule about when one should consider filing or when they should in fact file.  However, there are several common circumstances that, taken together, can provide a litmus test as to whether you should seriously consider Bankruptcy.

When you calculate your monthly budget, there is a shortfall. 
This is a big clue that something has to be done about your finances, particularly if you have a shortfall even before accounting for debt payments!  If you are incurring new debt on credit cards or lines of credit in order to cover the shortfall, you are likely caught in a circle of debt that you will not be able to get on top of.  Even once the shortfall is corrected, the interest rates will keep the debt growing higher than your minimum payments will be able to keep up with. 
Of course, this alone does not mean you need to run down to the court and file your Bankruptcy petition.  You may be able to find relief just by closing unnecessary accounts, stopping incurring new debt, negotiating settlements or lower repayment options, lowering your monthly expenses, or looking for additional or higher paying work.
You are withdrawing money from retirement accounts to pay debts. 
Every week, I encounter at least one case where a client has emptied his 401(k) or IRA to make debt payments, and is going to have to file Bankruptcy anyway.  In a Bankruptcy, your existing IRA, 401(k) and other retirement accounts are off limits to your creditors and the bankruptcy trustee.  Don’t jeopardize your retirement or emergency funds to make small payments on a debt that will still be overwhelming, even after you withdraw all of your retirement funds.
This is not to say that these funds could be used to stop the cycle of debt early on.  If you can settle or pay off all of your debt in one go, and still have working years ahead to recover from the hit, then withdrawing retirement funds may be a good option.  However, if you are more advanced in age, and retirement withdrawals would only cover a fraction of your debt, then consult an attorney about other options for dealing with your debt.
You are incurring personal debt to keep a small business afloat.
This is a tough one for many small business owners.  Knowing when to throw the towel in on a business is similar to knowing when to end a marriage, as there is often so much that has already been personally invested. 
Certainly the uncertainty of economic conditions makes timing difficult in cases of a business.  No one has a crystal ball for economic recovery (especially Congress!) but it is important to be realistic.  Just as in poker, you have to know when to hold ‘em and when to fold ‘em.  In other words, rather than betting on the odds of winning (or of a rapid recovery), make a decision about how much you are willing to lose before getting up from the table (cut your losses before they are too much to handle).  When recovery comes, there will be opportunities to start new business ventures and still utilize the good will of your old business. 
If you are incurring personal debt on your business, you should consult a Bankruptcy attorney to determine just how much you can stand to lose.  Remember, most small business do not enjoy the same level of limited liability as large corporations.  Most small business owners, be it LLC, C-Corp, S-Corp or Limited Partnership, are often required to sign personal guarantees on business debts.  In these cases, its not just how much your business can afford to lose, its how much your family can afford to lose. 
You have been sued on a debt.
This usually brings people to the Bankruptcy inquiry pretty quick.  Aside from settlement, a payment plan or payment in full, nothing can stop the execution of a judgment in the form of wage garnishments, bank account garnishments and repossessions except Bankruptcy.  In Arizona, a Judgment Creditor can garnish up to 25% of the debtor’s gross wages.  For many working families, this is a direct threat to being able to put food on the table. 
Often by the time a garnishment is ordered, there is little that can be done in the form of payment arrangements or settlements.  While payment plans for the full amount of the debt (plus attorney fees and court costs) can be paid in monthly payments over time, many creditors prefer to garnish the maximum allowable.  This can also have negative effects on one’s job stability, as employers do not like performing these garnishments. 
Lawsuits on debts usually do not get filed until an account is seriously delinquent, sometimes as long as eight months to a year.  There is usually plenty of opportunity to search out a solution before it comes to a judgment. 
Be proactive.
If you are always robbing Peter to pay Paul, Peter will eventually go broke.  The first step is to stop incurring new debt.  The second is to seek out all potential solutions to managing and reducing debt.  Be wary of any individual or service that promises to solve your debt for a substantial fee.  Most effective remedies are do-it-yourself and can be done for free or minimal cost.  A free initial consultation with a Bankruptcy attorney is often a great first step.