Your Assets in Bankruptcy
As we discussed in our last blog post, when you file a bankruptcy case everything you own at that moment in time comes under the jurisdiction of the bankruptcy court. The law has to pick a point in time—when your case is filed—to look at your financial situation, especially at what debts you owe and what assets you own at that time.
In most consumer cases—whether under “straight bankruptcy” or under “adjustment of debts” –you discharge (legally write off) all or most of the debts that you owed at the time you filed your case, and you keep all of the assets that you owned at that time.
But this practical need to focus on a specific point in time for asset purposes has some wiggle room in the bankruptcy law. If you sell or give away some of your assets during the time before filing bankruptcy, sometime those sales or gifts can be undone.
“Fraudulent Transfers” in Bankruptcy
This often misunderstood aspect of bankruptcy involving undoing such sales and gifts goes by the label, “fraudulent transfers.” Even that label adds to the confusion because a sale or other kind of transfer does not have to be fraudulent for it to be a “fraudulent transfer.” Let us explain.
The Purpose of “Fraudulent Transfers” in Bankruptcy
One of the key principles of bankruptcy involves the fair distribution of assets to creditors, when there is any such distribution. As mentioned above, in most consumer bankruptcy cases, there is no such distribution to creditors because all of the debtor’s assets are “exempt,” protected for the debtor’s benefit. But the principle remains, coming into play occasionally in consumer cases. And when it does, it can come as a rude shock. So it is important to understand and, where possible, avoid “fraudulent transfers.”
Under certain circumstances the bankruptcy court has jurisdiction not only over assets that the debtor owns when the case is filed but also over assets previously owned by the debtor but sold or given away during a period of time before the filing date. The purpose for this is very practical: to discourage debtors from disposing of assets before filing bankruptcy, assets which would otherwise have been distributed in the subsequent bankruptcy to the creditors.
The Bankruptcy Trustee’s Power to “Avoid” “Fraudulent Transfers”
So the law provides that under certain circumstances if a debtor transfers assets during the two years before the bankruptcy filing, that transfer can be undone—”avoided.” As a result, the transferred assets revert back to the debtor, the individual or business filing bankruptcy. Then the bankruptcy trustee can sell the assets and distribute the proceeds of sale to the creditors.
“Fraudulent Transfers” that Are Actually Fraudulent
One kind of “fraudulent transfer” involves assets sold or given away “with actual intent to hinder, delay, or defraud” the debtor’s creditors. The debtor is purposely hiding assets from its creditors. That’s called an intentionally fraudulent transfer.
“Fraudulent Transfers” that AREN’T Actually Fraudulent
A constructively fraudulent transfer occurs when the debtor filing bankruptcy simply gets ‘less than a reasonably equivalent value in exchange for such transfer or obligation.” There isn’t necessarily any evidence that this was done to hide anything from the creditors, but the debtor didn’t get paid what the asset being transferred was worth.
The idea is that under certain very specific circumstances of financial exposure, if a debtor transfers an asset without getting paid adequately for it—in money or some other fair exchange—and files bankruptcy within two years thereafter, the bankruptcy trustee (on behalf of the creditors) should be able to undo that transfer, and get paid the proceeds of the sale of that asset.
There are four very specific circumstances in which constructively fraudulent transfers can occur. Detailing all of these is beyond the scope of this blog post. But to give you a better idea about this, one of these four circumstances is if the debtor is insolvent when the transfer was made, or the transfer itself made the debtor insolvent. The point is that businesses and individuals should generally be able to sell or gift away their assets without worrying about those sales or gifts being undone in the future. But if that business or individual is selling or giving away assets while it is insolvent, and then ends up filing bankruptcy, then those transfers are seen as having “constructively” defrauded the business’ or individual’s creditors out of the value of that asset.
Fraudulent transfers are among the most complicated concepts in bankruptcy. This has been just a basic overview. Again, fraudulent transfers are not often involved in consumer cases—more so in small business ones. Either way, one of the benefits of having a highly competent bankruptcy attorney in your corner is that these kinds of potential problems can be discovered, discussed, and resolved in a way serving your best interests.