If you win a sizeable personal injury settlement before bankruptcy, it's possible that you won't even have to file bankruptcy. If your settlement allows you to pay off or at least control your debt, it might be a better option than bankruptcy, which can damage your credit score for up to 10 years. If you do file bankruptcy after a settlement, you might lose some or all of it. The settlement might disqualify you from filing Chapter 7 bankruptcy.
Chapter 7 Qualification
To qualify for Chapter 7 bankruptcy, your income must be sufficiently low. Except in rare circumstances, you can't file Chapter 7 unless your annualized income, based on the six months before filing, is below the median in your state. Because settlement proceeds are considered income for the purposes of bankruptcy, your settlement may push you over the median and disqualify you from Chapter 7.
Chapter 7 Exemptions
Exemptions are laws that protect debtor assets in bankruptcy. If you qualify to file Chapter 7, you still might lose your settlement proceeds if they exceed your state's bankruptcy exemptions. Assets valued in excess of exemptions are known as non-exempt assets. The court can seize such assets and use them as payment for your debts. For example, if your settlement was for $100,000 in cash, and your state has only a $5,000 exemption for cash, $95,000 of your settlement would be considered non-exempt.
If you want to protect the proceeds from your settlement, a Chapter 13 bankruptcy may be your best option. This type of bankruptcy is essentially a debt negotiation supervised by the bankruptcy court. You must pay your creditors for up to five years under the terms of a plan approved by the court. However, you don't have to worry about losing the money from your settlement, as you might in Chapter 7. Bankruptcy law protects all assets of a Chapter 13 debtor from creditors.
Chapter 13 Payment
The size of your settlement payout might have an effect on the amount you must pay creditors. Your payment is based primarily on the amount of your disposable income, which is not affected by your settlement. However, bankruptcy law requires you to pay your unsecured creditors, such as your credit card companies, at least as much as they would have received if you had filed Chapter 7 bankruptcy. If the size of your settlement exceeds your Chapter 7 exemptions, you will have to include this money in your payments.
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