This post is the fifth in a series in which I discuss fraudulent transfers. This one deals with the consequences of fraudulent transfers, and the importance of prebankruptcy planning.
E. Denial Of Discharge And The Loss Of Assets
A discharge may not be available to a debtor who engages in prepetition fraudulent transfers:
The court shall grant the debtor a discharge, unless — . . . the debtor, with intent to hinder, delay, or defraud a creditor or an officer of the estate charged with custody of property under this title, has transferred, . . . or has permitted to be transferred, removed, destroyed . . . — . . . property of the debtor, within one year before the date of the filing of the petition . . .
And as I have discussed in great detail in my previous fraudulent transfer posts, the bankruptcy trustee can avoid the transfers and seize the assets. Furthermore, once the debtor has transferred the asset, it no longer belongs to the debtor, and cannot be exempted in the debtor’s bankruptcy.
Therefore, the transfers should be reversed prior to filing for bankruptcy protection. Of course, if the debtor fully discloses the transfers in the bankruptcy papers, then the intent requirement in the first definition of fraudulent transfer might be overcome.
IMPORTANT PREBANKRUPTCY PLANNING
Prevent The Loss Of Assets
I have had clients who have transferred assets prior to retaining my services. For example, I had an elderly man (and now some people think that I am an elderly man — ouch!) who transferred his mobile home to his son a few months before meeting with me. He continued to live in the home. If we had filed his papers without taking any action on the home, the Chapter 7 Trustee would have seized the home from the man’s son and my client would have been out on the streets. Worse still, since the home was no longer in my client’s name, he would have been unable to exempt any of the equity in the home. Therefore, I had him reverse the transfer: His son reconveyed the house back to him prior to filing bankruptcy papers. Then he was able to exempt all of the equity in the home and thus keep the home.
Preserve The Right To Discharge
As we have seen, fraudulent transfers can render a debtor ineligible for discharge. Therefore, undoing the transfers may be crucial to preserving the right of the debtor to a discharge. Undoing prepetition fraudulent transfers prior to filing is a perfectly legitimate form of prebankruptcy planning that has been accepted by the Ninth Circuit Court of Appeals. See In re Adeeb, 787 F.2d 1339, 1346 (9th Cir. 1986):
We therefore hold that a debtor who has disclosed his previous transfers to his creditors and is making a good faith effort to recover the property transferred at the time an involuntary bankruptcy petition is filed is entitled to a discharge of his debts if he is otherwise qualified. We emphasize that the debtor must be making a good faith effort to recover the property prior to the filing of the involuntary petition, and he must actually recover the property within a reasonable time after the filing of the involuntary petition. A debtor’s failure to establish these conditions would justify relief under section 727(a)(2)(A).
In sum, if you are a bankruptcy attorney, it is very important that you ask your clients about any transfers of assets, and take corrective prepetition action to avoid postpetition problems.
However, even prepetition planning has its limits. This is vividly illustrated in the case In re Beverly, 374 B.R. 221 (B.A.P. 9th Cir. 2007), aff’d, 551 F. 3d 1092 (9th Cir. 2008). The Court began its opinion with the following introduction:
The bankruptcy planning dispute presented in these related appeals requires us to transit waters made turbulent by cross-currents of exemptions, fraudulent transfer, denial of discharge, and divorce. We publish to dispel the myth that the toleration of bankruptcy planning for some purposes insulates such planning from all adverse consequences — it does not.
In re Beverly, 374 B.R. at 226.
The debtor in Beverly was an attorney who was facing a large malpractice judgment at the same time he was going through a divorce. He and his soon-to-be ex-wife agreed to a marital settlement agreement that conferred on him over $1,000,000 in exempt retirement funds, and on his nonfiling spouse about the same value in nonexempt assets. The debtor then filed for Chapter 7 relief anticipating that he would keep all of his assets by exempting them. The Bankruptcy Appellate Panel (“BAP”) held that the transfer of the nonexempt assets to the ex-wife was a fraudulent conveyance and permitted the Chapter 7 Trustee to seize them. It also held that the debtor be denied his Chapter 7 discharge.
Beverly should serve as a tocsin against greed. Although the BAP didn’t explicitly state this, it is quite reasonable to conclude that if the debtor has received 50% of the exempt assets and 50% of the nonexempt assets, with his ex-wife being similarly compensated, that the BAP would not have ruled as it did. As the BAP put it:
. . . there is a principle of “too much.” In classical terms, it is the Sword of Damocles. In the agrarian terms used by the Fifth Circuit affirming the denial of a discharge, “when a pig becomes a hog it is slaughtered.”
Id. at 245.
In the next post I will discuss defenses against fraudulent transfer avoidance actions.
If you are facing overwhelming debt and are think fraudulent transfers might be an issue in your case, contact a highly knowledgeable and skilled bankruptcy attorney to guide you through the process.