Bankruptcy – Punishment or Reward?

Bankruptcy is neither a punishment nor a reward. It is a method to smooth out a period of financial instability. Some may argue that a person who gets a discharge from his debts is getting rewarded for bad financial management, specifically a over use of credit cards. True, but it would most likely be applicable to maybe less than 1/3 of all filings. Although overextended credit may include over-use or abusive use of credit cards, it would also include purchases of homes and cars that are beyond the financial capability of the debtor. It is interesting to note that the major cause of personal bankruptcy has been recently reported to be not from overextended credit but from a major illness or injury. It is clear that a debtor who cannot work, cannot pay his bills. Such situation could cause the debtor to experience such financial stress that he will inevitably seek some form of relief from the bankruptcy court.

In a piece written by Michelle J. White entitled Bankruptcy Reform and Credit Cards, Ms. White states that there are two conflicting functions of bankruptcy law. The first is that bankruptcy provides the debtor with what she calls consumption insurance. The basis behind this is that consumers can smooth out their consumption patterns over time, especially when their future incomes and expenses are unknown. She goes on to say that with this type of consumption insurance, debtors can explore and expand into self-employment knowing that should their venture fail, they have an out. This could be perceived to be a reward.

The second objective is to discourage default. Debtors who default on their debts pay a price because lenders will be wary to extend credit to those who do default. Additionally, default will also increase costs to those debtors in the way of higher borrowing rates. This, on the other hand, is a punishment.

The general consensus among bankruptcy attorneys is that a debtor who ventures into bankruptcy court for financial relief, will usually experience a period of time, 2 years on average, after the case filing where he will have to rebuild his credit worthiness. This can also be viewed as a penalty. But on the other hand, he can also be viewed as being rewarded once that time passes because if successful, those costs to borrow will generally fall back to more reasonable levels.

In the grand scheme of things, yes there are a small percentage of bankruptcy filers who abuse the system. However, the majority of those who do file bankruptcy find the relief that they so desperately need.