Bankruptcy Myths

While bankruptcy is not a panacea for poor money management or business decisions, it offers some protection to horse owners.

"Steal a little and they throw you in jail," Bob Dylan wrote a few years ago, "steal a lot and they make you king." In today's economy that means you receive a huge government bailout if you accumulate billions in debt and are "too big to fail," but for everyone else, you're on your own. Bankruptcy might be the only viable alternative for many individuals and businesses, horse owners among them.

Since October 2006, when bankruptcy law went through a significant overhaul, adding filing limitations and consumer protections, bankruptcy filings have shown a steady rise. There are no reliable figures on how many bankruptcies directly involve horse owners and horse businesses, but the precipitous drop in the Thoroughbred auction market and the alarming number of horses abandoned because their owners cannot afford to care for them are two strong indicators that the industry has been hard hit by the recession.

The first step toward deciding whether bankruptcy is the best course of action is learning about the process and the options. Just as important is dispelling some of the myths and misconceptions that have arisen around bankruptcy.

Myth #1: Bankruptcy = Failure

Bankruptcy often comes with a stigma-- financial irresponsibility, poor credit risk, lack of business sense. That characterization isn't fair in many cases, and it is important to acknowledge that bad things can happen to good people.

A job lost, a catastrophic illness or injury (to an owner or to her horse), a barn fire, a market turnaround, skyrocketing prices for feed, the recession ... all can drive debt beyond someone's ability to pay.

Bankruptcy "gives to the honest but unfortunate debtor ... a new opportunity in life and a clear field for future effort, unhampered by the pressure and discouragement of preexisting debt." The U.S. Supreme Court made that observation 75 years ago; it is as true today as it was then. There is nothing dishonorable about seeking a fresh start.

Myth #2: Bankruptcy is the Only Option When Debt is Out of Control

While bankruptcy is one solution to a personal or business debt crisis, it might not be the only solution, or the best one. Because bankruptcy has a serious and long-term financial impact, it should be considered a last resort.

A good start is to contact creditors directly and explain that you intend to pay the bills when you can--but only if that's realistic. Promising to pay, then failing to do so, will destroy whatever credibility you might have had with your creditors. Explain the situation and propose a compromise. It can be a grace period, a lower interest rate or smaller payments, a settlement for less than the amount owed: something to show your good faith and intention to pay. Whatever you propose, keep it reasonable and manageable.

If the direct approach does not succeed, credit counseling might be the next step. Creditors who refuse to negotiate directly with you might be more willing to work through a credit counselor with a good track record.

At a minimum you should expect a credit counselor to evaluate your finances (income, debts, assets, expenses), discuss bankruptcy and the alternatives, and work with you to establish a budget. Many credit counselors also will try to negotiate a settlement with creditors. Credit counselors advertise extensively on the Internet, on television, and in the telephone book's business listings, and selecting one can be a daunting task. Before signing on with a credit counseling service, check it out through the Better Business Bureau at www.bbb.org.

Credit counseling can serve an additional purpose, even if bankruptcy turns out to be the chosen option. With very few exceptions, any individual who plans to file for bankruptcy must meet with a government-approved credit counseling service within 180 days of filing the bankruptcy petition. The required credit counseling can be done in person, by phone, or online, and approved counselors must provide the service free if you cannot afford to pay. A certificate will be issued upon completion.

Credit counseling might reveal an alternative to bankruptcy, but if not, working with an approved service provider initially will satisfy a subsequent filing requirement. A list of approved credit counselors is available from the bankruptcy court clerk's office in the district where you live or online at www.justice.gov/ust/eo/bapcpa/ccde/cc_approved.htm.

Myth #3: All Bankruptcies are the Same

Every debtor's financial situation is unique, and every bankruptcy is different. When or whether to file for bankruptcy protection is a decision that should not be made without the advice of an attorney familiar with general bankruptcy law and with situations similar to yours, especially if horses or other animals are involved.

Although each bankruptcy is unique, bankruptcy proceedings fall into one of several general types, based on which portions of the Bankruptcy Code apply. In all of the following examples, the bankruptcy is initiated by filing a petition with the federal bankruptcy court in the judicial district where the debtor lives or where the business is organized or located. In addition to the petition, a filing fee must be paid and other information provided. Financial documentation includes a list of assets and liabilities, a schedule of current income and expenses, and tax returns.

Filing a bankruptcy petition stops nearly all collection efforts by creditors and gives a debtor some breathing room free of harassing phone calls and letters.

The following is a summary only and is not intended to be an inclusive list of legal or procedural requirements. More detailed information is available by following the "Bankruptcy Court" link at www.uscourts.gov. It is possible to file for bankruptcy without legal counsel, but the procedural rules are complex, and a mistake or oversight might result in dismissal of the petition. An attorney should be consulted for assistance prior to filing if at all possible.

Chapter 12 bankruptcies are available only to "family farmers" and "family fishermen" who have a regular and reliable income stream. A Chapter 12 bankruptcy allows the farm owner to retain his or her property and the business to continue operation, contingent on a court-approved plan for the debtor to repay creditors over a period spanning several years. It has several advantages over other reorganization-type bankruptcies (Chapter 11 and Chapter 13, discussed later). The process is simpler and less expensive than a Chapter 11 proceeding, and there are higher debt limits than are allowed under Chapter 13.

Horse farm owners can take advantage of a Chapter 12 bankruptcy only if the business qualifies as a "family farm." This sounds obvious, but not all horse businesses satisfy the "family farm" requirements.

A Texas bankruptcy court ruled, for example, that a training and riding lesson facility where the owner of the farm also owned all the horses qualified as a "family farm." A Tennessee court reached a similar conclusion regarding a farm owner who bred, sold, and trained Tennessee Walking Horses. A key factor in both decisions was the fact that both horse operations were exposed to the same risks as other types of family farm operations.

On the other side of the fence, bankruptcy courts in Illinois and Oklahoma have ruled that neither a breeding farm nor a training barn where the farm owner did not own the horses being trained qualified as family farms. Solidly straddling the fence was a court in West Virginia, which held that one portion of a horse owner's business (raising horses) qualified as family farming, while another part of the business (boarding and training) did not.

In a Chapter 7 bankruptcy, sometimes called a "liquidation" proceeding, property owned by the debtor is sold and the proceeds of the sale are distributed to creditors. There are no provisions for continued operation of a business or a repayment plan. Following distribution of proceeds from the sale of the debtor's property, any remaining debts are "discharged" and the debtor starts anew. Not all debts can be discharged, however. For example, non-dischargeable debts in a Chapter 7 bankruptcy include alimony and child support, certain taxes, student loans, and debts for death or personal injury resulting from driving a vehicle while intoxicated.

A debtor will be allowed to keep some property after the bankruptcy, but exactly what property varies. "Exempt" property is defined by federal and state law, and the exemption schedule that must be used depends on where the bankruptcy petition is filed. Bankruptcy petitioners in 16 states can use the federal exemption schedule or the schedules in the respective states, but the majority of states require petitioners to use state exemption schedules only.

Neither the federal nor state exemption schedule is generous, and review of exempt property guidelines with an attorney is strongly advised. Some examples from the federal exemption schedule:

A Homestead exemption (currently $20,200) applies to the debtor's residence. Homestead exemptions vary from state to state, and if a debtor has equity in a residence that exceeds the protected exemption amount, the property could be sold by the bankruptcy trustee to pay creditors.

Two other exemptions are automobile ($3,225) and household goods ($10,775). Many others can be added at the state level, and they might include tools and equipment used in a business or trade; agricultural equipment and livestock; insurance policies; workers compensation, unemployment, and other benefits; pensions; and other personal property.

Depending on the state where the petition is filed, horses, pets, and other animals might be exempt up to a specified (usually low) value either as livestock or personal property, or they might be subject to a special "wildcard" exemption. Whether an asset actually will be sold to raise money for creditors depends on the expected sale price. A $50,000 show horse is more likely to be sold than Fluffy the barn cat.

In any case, a Chapter 7 proceeding in which a debtor does not give up property to pay creditors is extremely rare.

A Chapter 13 bankruptcy, sometimes referred to as a "wage earner's plan," allows a debtor to propose a schedule for debt repayment in installments over a period of three to five years. If approved by the court, a Chapter 13 bankruptcy allows a debtor to keep his or her residence, provided that past-due mortgage payments are made and that the debtor makes timely mortgage payments after the filing. Other property, including horses and other animals, also may be retained by the debtor.

The repayment plan constitutes an enforceable contract between the debtor and the creditors. Regular payments are made to the bankruptcy trustee, who then makes distributions to creditors. Failure to make scheduled payments will put the debtor's property at risk of foreclosure.

Finally, a Chapter 11 bankruptcy, often called a "reorganization," is generally used to restructure a business, whether a corporation, partnership, or sole proprietorship. It is similar to bankruptcies under Chapters 12 and 13, with debtors proposing a multiyear plan to repay creditors while keeping the business operating to generate income. Horse farm owners may file under Chapter 11, but a Chapter 12 filing might be more advantageous if the horse business qualifies as a family farm.

Myth #4: Credit Ratings Never Recover After Bankruptcy

The record of a bankruptcy shows up on credit reports for seven to 10 years. Credit might be difficult to obtain following bankruptcy, especially for a big-ticket item such as a mortgage or automobile loan, but some creditors might be willing to take the risk. The reasons are twofold.

First, there is a mandatory waiting period between bankruptcy filings, currently eight years for Chapter 7, shorter periods for Chapter 13. From a creditor's standpoint, this means a person coming out of a Chapter 7 bankruptcy cannot seek another debt discharge for several years. New debt acquired after the bankruptcy thus is insulated from discharge, protecting a creditor. Second, a person coming out of a Chapter 7 bankruptcy has no outstanding debt to compete with new financial obligations.

Take-Home Message

Filing for bankruptcy is complicated, time-consuming, and has serious financial consequences. Anyone considering bankruptcy should consult with an attorney and explore alternatives. Bankruptcy might be a short-term solution to pressing financial problems, but it is not a panacea for poor money management or questionable business decisions. Financial counseling before debt reaches a critical level is essential.

About the Author

Milt Toby, JD

Milt Toby is an author and attorney who has been writing about horses and legal issues affecting the equine industry for more than 40 years. Former Chair of the Kentucky Bar Association's Equine Law Section, Milt has written eight nonfiction books, including national award winners Dancer’s Image and Noor. He teaches Equine Commercial Law in the University of Louisville's Equine Industry Program.

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