James R. Balmforth: Fraudulent Transfers Before Bankruptcy

Perfectly honest consumer debtors sometimes make the mistake of transferring an asset to a friend or family member before filing bankruptcy. This can happen innocently enough, as for example, where a debtor gives an old car of little value to an adult child months before he even considers filing bankruptcy. Despite the fact that he had no actual intent to defraud any creditor, and despite the fact that if he had not transferred this old car of minimal value, he may well have been able to exempt it in Chapter 7 bankruptcy, the Bankruptcy Code nevertheless treats such a transfer as “fraudulent.” Sadly, bankruptcy law is full of such “gotcha” pitfalls for debtors, particularly when it comes to Chapter 7 bankruptcy, and the Bankruptcy Code is harsh and unforgiving when it comes to “fraudulent transfers” by debtors prior to bankruptcy.

11 U.S.C. Section 548

Fraudulent transfers are defined in 11 U.S.C. Section 548 as transfers by the debtor of an interest in property (either voluntarily or involuntarily) within two years before filing bankruptcy, where either the debtor actually did intend to defraud his creditors or, far more commonly, where the debtor did not receive “reasonably equivalent value” for the transferred asset and the debtor was either already insolvent or became insolvent as a result of the transfer.

Fraudulent Transfers Can Hurt Bankruptcy

Fraudulent transfers can have dire consequences in bankruptcy. If the transfer involved actual fraud—meaning that the debtor transferred the asset with actual intent “to hinder, delay, or defraud” his creditors—and such transfer occurred within one year prior to filing bankruptcy, then under Bankruptcy Code section 727(a)(2)(A), the court may deny the debtor from obtaining a bankruptcy discharge at all!

Constructive Fraud

Far more common, however, are situations involving “constructive fraud” where, as described above, the debtor had no actual intent to harm anyone, she simply transferred an asset for less than “reasonably equivalent value” while she was either insolvent or became insolvent as a result. As noted above, under section 548, if such a constructively fraudulent transfer was made within two years prior to filing bankruptcy, then the bankruptcy trustee can “avoid” the transfer. This means that the trustee can sue the family member to whom that old car was given to get the car back. Obviously, this is a disastrous result for the adult child who received the car, and who is a completely innocent bystander in this scenario.

Getting Assets Back to Reverse Fraudulent Transfers Prior to Bankruptcy

In many cases, however, by carefully questioning our bankruptcy clients prior to filing, we can avoid these negative consequences by advising the client to try to get the transferred asset back prior to filing. This is because if one is filing bankruptcy in Salt Lake City or anywhere within the Ninth Circuit, the bankruptcy court will allow debtors to reverse or undo a fraudulent transfer prior to filing bankruptcy. Such a rule follows, what I think is a universally held common senses value that one should be allowed, if given the chance, to correct a mistake after receiving advice from an attorney.

That’s what the Ninth Circuit essentially said in the case In Re Adeeb, 787 F.2d 1339 (9th Cir.1986). For a fraudulent transfer to exist in a bankruptcy case, the transferred asset must have remained transferred as of the bankruptcy filing date. If the debtor recovered the asset, then it is no longer “transferred.” No harm; no foul.

So, if you are thinking of filing bankruptcy in Utah or the Ninth Circuit, and you gave your daughter an old clunker last year as a gift, then you should have her sign title back over to you before filing bankruptcy!

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