Excerpted from The Biggest Legal Mistakes Physicians Make: And How to Avoid Them
Edited by Steven Babitsky, Esq. and James J. Mangraviti, Esq. (©2005 SEAK, Inc.)

Download Free 646 Page E-book: The Biggest Legal Mistakes Physicians Make and How to Avoid Them

Executive Summary

The bankruptcy process consists of intertwined procedural and substantive rules that must be carefully observed if one is to maximize the probability of achieving his or her objectives, whether as debtor or as creditor. Although physicians, thanks to their potential for achieving significant wealth, are not disproportionately represented in the bankruptcy process as debtors, for whom the objective is generally to be released from preexisting debt and to obtain a fresh start going forward, it is nevertheless not uncommon that a physician, like any business person, is compelled to seek bankruptcy relief. The routine events that might lead a physician to contemplate bankruptcy include the following:

  • An inability to pay back student loan obligations pursuant to the terms of the notes;
  • The failure, either because of inattention or cash-flow difficulties, to sufficiently remit estimated tax payments to the government, resulting in accumulated income and self-employment taxes, interest, and penalties, beyond the physician’s ready ability to pay;
  • Cash flow in a start-up medical practice that is insufficient to service the debts incurred to finance such start-up through, for example, business loans or credit card borrowing;
  • Downsizing a practice in which the physician is personally liable for future rent on a long-term lease; and
  • Investing in real estate, where the market falls out and the value of the real estate falls below the amount of the encumbering mortgage obligations.

With the potential to generate high incomes and to acquire significant assets and investments comes the potential to incur correspondingly high business and personal expenses and to incur extraordinary amounts of debt. Therefore, where bankruptcy is implicated for the physician, such a case is likely to be more involved than the routine consumer bankruptcy. As a result, it is incumbent on the physician, more so than on an average debtor, to approach bankruptcy with the resolve to become educated as to the rights and obligations that accompany the bankruptcy and to scrupulously observe its requirements.

Additionally, physicians are often in a financial position to extend credit to others. For example, a physician owning a small business complex might sublease various units to tenants. Another might develop real estate and take back a second mortgage for investment income when such real estate is sold. In these contexts over long periods of time, a physician is likely to be confronted with the occasional borrower who defaults on rent or mortgage payments and then files bankruptcy, leaving the physician subject to the creditors’ rights provisions of the Bankruptcy Code.

This section enumerates some of the bankruptcy mistakes that must be avoided by a physician as debtor or creditor in confronting the bankruptcy process. Some of these mistakes can thwart not only the legitimate expectations that the physician sought to vindicate in the bankruptcy process, but can also have catastrophic economic ramifications for the physician.

Mistake 1        Failing to Precisely Disclose Information Required by Bankruptcy Schedules and Forms

Failing to precisely disclose assets and other financial information required by the bankruptcy schedules and forms can result in a denial of discharge of debts, which is the primary objective in filing bankruptcy. Moreover, it prevents the debtor’s attorney from accurately exempting all of the physician’s assets that may be entitled to protection from creditors in the case. Finally, oversights in the required financial disclosures raise questions as to the credibility and accuracy of other information on the forms and might thereby invite additional scrutiny where none was warranted, causing additional anxiety and legal costs in completing the process. 

Action Step     Physicians should not take lightly their obligation to disclose their assets and financial background information. Bankruptcy provides the potential for a drastic benefit in the form of a discharge of debts, but with the benefit comes the obligation to present comprehensive disclosures of assets and other financial background transactions and information.

Mistake 2        Failing to Carefully Determine the Ability to Exempt Certain Assets

Physicians may fail to carefully determine the exemptability of all their assets, both to preserve as many assets as possible for themselves and their family and to avoid an unpleasant surprise in bankruptcy upon learning that an asset once thought to be exempt must now be turned over to the creditors. For example, retirement plans present a number of complexities depending on their type and structure. Many a debtor is informed that a retirement vehicle is exempt from creditors only to learn in bankruptcy that the particular retirement vehicle at issue is an exception to the rules. Similarly, real estate that is owned as tenants by the entireties with a spouse is exempt from non-joint creditors in many states, and one would not want to miss out on this benefit where it is applicable.

Action Step     Physicians should work carefully with competent bankruptcy counsel to ensure that counsel is aware of all of their assets, such as the titling and governing documents of those assets, including deeds to real estate, certificates of title for vehicles and bank accounts, and plan documents for trusts and retirement plans.

Mistake 3        Assuming Old Tax Debts Will Be Discharged Under Chapter 7 or Chapter 11

It is safest to assume that tax obligations are generally not dischargeable under chapter 7 or chapter 11 of the Bankruptcy Code. There are numerous exceptions interspersed throughout the Bankruptcy Code that work to exclude various taxes from discharge. Nevertheless, depending on such issues as the age of the taxes, the dates of the filing of the tax returns, the pendency of any prior offers in compromise, the existence of any prior bankruptcies, and other issues, there are taxes that are eligible to be discharged. In those cases where the criteria for discharge are satisfied, obtaining a bankruptcy discharge of taxes can provide a significant economic benefit to a debtor.

Action Step     Advance preparation is the key to ensuring that prepetition taxes are eligible for discharge in bankruptcy. Physicians should work carefully and closely with their tax adviser and bankruptcy attorney to ensure that their bankruptcy attorney has the applicable facts concerning the nature of the tax liabilities, including the type, year, date the returns were filed, and the dates of assessment by the taxing authority, along with any other relevant circumstances or facts requested by the attorney.

Mistake 4        Failing to Consider Chapter 13 As a Method for Resolving Tax Debts

Under chapter 13, unlike the other available bankruptcy chapters, taxes can be repaid without interest and potentially over a longer period of time (five years from the bankruptcy filing rather than six years from the date of assessment of the tax).

Action Step     Physicians who are consulting with an attorney over potential bankruptcy options for their tax problems should remind the attorney to consider whether they are eligible for chapter 13 and cooperate with the attorney in determining whether chapter 13 presents the optimum approach.

Mistake 5        Violating the Automatic Stay

Once a bankruptcy case is commenced by filing a petition with the bankruptcy court, a stay of all collection actions automatically takes effect to preclude creditors from taking any further steps toward collecting what they are owed. After the bankruptcy filing, the automatic stay precludes the creditor from, for example, filing a lawsuit to collect a debt, continuing a suit that has already begun, collecting on a judgment that has previously been entered on a suit, repossessing collateral, foreclosing a mortgage, or even contacting the debtor for payment.

Action Step     After receiving a court notice or otherwise becoming advised that a debtor is in bankruptcy, a creditor should immediately cease all collection efforts and seek counsel to determine the scope of the stay and to obtain relief from the automatic stay from the bankruptcy court, if appropriate.

Mistake 6        Failing to File a Proof of Claim

Generally, in order to share in the payment distributions that are made to creditors in a bankruptcy case, it is mandatory to file a proof of claim with the bankruptcy court setting forth the amount that is owed. Filing a proof of claim beyond the due date will lower a claim’s priority level, making it unlikely that any payment will be received at all. Even in chapter 11 cases where it may not be mandatory to file a proof of claim, the safest practice is to file one anyway, since the amount set forth in a filed proof of claim will supersede the amount set forth in the debtor’s schedules and such proof of claim will be deemed filed in any bankruptcy chapters to which the chapter 11 case might be subsequently converted.

Action Step     Physicians should consult with counsel for advice on the necessity for filing, the timing of filing, and the proper completion of a proof of claim form. Short of retaining counsel, physicians should, at a minimum, pay careful attention to all notices they receive from the bankruptcy court reflecting deadlines for filing proofs of claim so that the potential for recovering a bankruptcy distribution on amounts owed is not jeopardized.

Mistake 7        Failing to Monitor Senior Mortgage Lenders

Physicians sometimes fail to monitor senior mortgage lenders, who might obtain relief from the automatic stay from the bankruptcy court and proceed to foreclosure, thereby wiping out all junior lien interests against an asset. For those who hold a second- or third-priority mortgage against real estate, notwithstanding any payment terms that the debtor has committed to under any bankruptcy reorganization plan, such junior lien rights can be eliminated if a senior lienholder obtains relief from the automatic stay to exercise foreclosure rights against the real estate. Generally, a senior lienholder’s foreclosure sale eliminates all encumbrances that are junior to the foreclosing interest.

Action Step     A secured creditor in bankruptcy whose collateral is subject to senior liens must carefully monitor the progress of the bankruptcy case for any actions by such senior lienholders that seek to recover collateral to the detriment of the junior secured claim. In some cases, the junior secured creditor will want to preserve its own foreclosure rights through its own motion to lift the automatic stay or want to negotiate with the senior secured creditor over servicing its debt or even acquiring its senior position.

Mistake 8        Failing to Observe Deadlines for Filing a Discharge or Dischargeability Complaint

Individual debtors will obtain a discharge of most debts, unless a complaint is filed within a strict deadline for objecting to the dischargeability of a particular debt or objecting to the discharge of all debts. In chapter 7 cases, the deadline for filing such a complaint is 60 days after the first date set for the initial meeting of creditors. This deadline gives creditors precious little time to analyze the background facts, undertake discovery under the Federal Rules of Bankruptcy Procedure, if necessary, and prepare and file the complaint in time.

Action Step     In appropriate circumstances, the deadline for filing a discharge or dischargeability complaint may be extended, but it is incumbent on a creditor to diligently pursue any discharge or dischargeability rights from the outset of the bankruptcy case in order to comply with the deadline for filing a complaint or to justify an extension of time for doing so, since an extension is much less likely to be granted if the creditor has not attempted to diligently construct its complaint.

Mistake 9        Failing to Observe Deadlines for Opposing Confirmation of a Plan

Similar to the proof of claim and discharge or dischargeability deadlines, it is of paramount importance that a creditor not waive its rights by failing to object to a reorganization plan. Once a reorganization plan is confirmed by the bankruptcy court, the creditor’s rights will have been largely fixed and determined with finality.

Action Step     Only through a careful review of a plan’s proposed treatment of a creditor’s claims and the exercise of its objection rights can a creditor ensure that a proposed plan complies with the applicable requirements for confirmation that are imposed by the Bankruptcy Code.

Mistake 10      Failing to Treat Bankruptcy As Litigation

Unlike certain other legal forums, bankruptcy is formal litigation. Adversary proceedings are separate lawsuits within a bankruptcy case. Contested matters are motions and other disputes within the general framework of the bankruptcy proceeding. In either type of litigation, the Federal Rules of Civil Procedure are generally incorporated through the Federal Rules of Bankruptcy Procedure. Additionally, the Federal Rules of Evidence apply. Although bankruptcy courts are often referred to as courts of equity, they are guided by the legal requirements of the Bankruptcy Code and the formal procedural rules previously discussed.

Action Step     Those who participate in the bankruptcy process as either debtor or creditor must approach it with the knowledge that it is governed by strict litigation rules. The bankruptcy court determines the rights of the parties after adversarial litigation in the traditional manner as other civil suits, based on the governing procedural rules and substantive law of the Bankruptcy Code and other legal principles.


Physicians who are aware of the various pitfalls in bankruptcy that are represented by these mistakes will maximize the chances that they obtain what they are legitimately entitled to, whether it be a discharge of debts or protection of a claim as creditor. 

Written by:
Steven B. Ramsdell, Esq.

Peer reviewed by:
Gregory H. Counts, Esq.

Download Free 646 Page E-book: The Biggest Legal Mistakes Physicians Make and How to Avoid Them