Should I Close My Bank Account Before Filing Bankruptcy?

When facing overwhelming debt, many individuals consider bankruptcy as a pathway to a financial fresh start. A common concern involves how bank accounts are handled during the bankruptcy process. Understanding the implications for your checking and savings accounts is important. This article clarifies how bank accounts are treated in bankruptcy proceedings and provides guidance on managing these assets.

Understanding Bank Account Treatment in Bankruptcy

Upon filing for bankruptcy, all assets owned by the debtor, including funds held in bank accounts, become part of the “bankruptcy estate.” This estate encompasses all property that can be used to satisfy creditor claims. The balance in your bank accounts on the exact date and time of your bankruptcy filing is included in this estate. Subsequently, an automatic stay goes into effect, which is a legal injunction that temporarily halts most debt collection efforts against you. This stay prevents creditors from taking actions like wage garnishments or attempting to collect directly from your bank accounts.

Despite the automatic stay, banks that are also creditors may have a “right of set-off.” This right allows a bank to apply funds from a debtor’s deposit account to an outstanding debt owed to that same bank, such as an overdraft, loan, or credit card balance. While the automatic stay generally pauses a bank’s ability to exercise this right without court permission, the underlying right to offset mutual debts that existed before the bankruptcy filing is preserved. A bank typically needs to seek relief from the bankruptcy court to exercise its set-off right after the automatic stay is in place.

Banks may also freeze accounts upon receiving notice of a bankruptcy filing. This administrative freeze is often implemented to preserve the funds until the bankruptcy trustee can determine whether the money belongs to the bankruptcy estate or is exempt. The freeze ensures that funds are not improperly disbursed before the trustee can assess the assets. While the automatic stay protects debtors from creditor collection, it does not always prevent a bank from administratively freezing an account to safeguard potential estate assets.

Bankruptcy law provides for “exemptions,” which allow debtors to protect certain assets, including specific amounts of money in bank accounts, from creditors and the bankruptcy trustee. These exemptions vary, with some states allowing debtors to choose between federal exemptions or their state’s own exemption laws. Many states offer a “wildcard exemption” that can be applied to any property, including cash or bank account funds, up to a specified value. Additionally, certain types of funds, such as Social Security benefits, disability payments, and some retirement funds, are often fully protected by specific exemptions, regardless of where they are held.

Strategic Considerations for Bank Accounts Before Filing

A common question is whether to close bank accounts before filing bankruptcy. Generally, closing accounts or moving large sums of money immediately before filing is not advised without legal guidance. Such actions can raise concerns with the bankruptcy trustee, potentially leading to scrutiny regarding “fraudulent transfers” or “preferential transfers.”

These terms refer to transactions where assets are moved or debts are paid to certain creditors within a specific timeframe before bankruptcy, viewed as an attempt to unfairly shield assets or favor one creditor. Any significant or unusual financial activity, especially within 90 days to one year preceding the filing, could be examined by the trustee.

Maintaining an account at a bank where you also have outstanding debt, such as a credit card or loan, carries the risk of the bank exercising its right of set-off. If you owe money to the bank where your account is held, the bank could apply the funds in your account to your debt, especially if this occurs before bankruptcy is filed. This could leave you without access to funds for necessary living expenses.

One strategy for managing funds before filing involves spending money on necessary living expenses. Using funds for rent, utilities, food, medical bills, transportation, or essential household items is permissible. Keep records of such expenditures. This ensures cash balances are reduced through ordinary means, rather than questionable transfers.

Another consideration involves utilizing available exemptions. If you have non-exempt cash in your bank account that exceeds exemption limits, you may convert some of it into an exempt asset. For example, using non-exempt cash to pay down debt on an exempt asset, like a car or home, or purchasing an exempt household item, can be a permissible form of “pre-bankruptcy planning.” This must be done reasonably and not with intent to defraud creditors, as excessive conversions could still draw trustee attention.

Opening a new bank account with a different financial institution can be a prudent step, especially if your current bank is also a creditor. This new account should be established at a bank where you have no prior debts or financial relationships. This can help mitigate the risk of account freezing or set-off rights by a creditor bank once your bankruptcy is filed.

Managing Bank Accounts During and Post-Bankruptcy

Once the bankruptcy case commences, the trustee assigned to your case will require detailed financial information, including bank statements. Trustees typically request statements covering the two to three months prior to your filing date, though they can ask for more, especially if they notice unusual activity. The trustee reviews these statements to verify the accuracy of your reported assets, income, and expenses, and to identify any transactions that might be considered preferential or fraudulent.

If your bank account contains funds that are not covered by an exemption, these “non-exempt” funds become part of the bankruptcy estate and may be liquidated by the trustee. The proceeds from such liquidation are then distributed among your creditors according to the bankruptcy code. However, it is relatively uncommon for most individuals to have significant amounts of non-exempt funds in their bank accounts at the time of filing, as many utilize pre-filing strategies to manage their cash.

Funds that are protected by exemptions can be used by the debtor during the bankruptcy process for living expenses. If a bank account is frozen, and the funds within it are exempt, your bankruptcy attorney can work with the trustee to have the freeze lifted, allowing you access to your protected money. Maintaining clear documentation of the source of funds, especially for exempt income like Social Security, can streamline this process.

Following the discharge of your bankruptcy, you will need to manage your banking relationships. While some banks may close accounts if they were also creditors or if there were issues during the bankruptcy, you can re-establish banking services. Many institutions are willing to open new accounts for individuals who have received a bankruptcy discharge.