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Archive for the ‘fraud’ tag

The Surprising Benefits: Fraud Debt Collections in Bankruptcy

July 16th, 2018 at 7:00 am

Being accused of defrauding a creditor is unusual in consumer bankruptcy cases. A creditor would have to jump through significant hoops. 

 

Most Debts are Discharged (Permanently Written Off) in Bankruptcy

The federal Bankruptcy Code has a list of the kinds of debts that are not discharged. This list details the conditions under which these kinds of debts don’t get discharged. (See Section 523 on “Exceptions to discharge.”)

Essentially, all your debts get discharged unless any of them fit one of the listed exceptions.

The Fraud Exception

One of the most important exceptions to discharge is the one stating that debts, “to the extent obtained, by… false pretenses, false representation, or actual fraud,” might not be discharged. (Section 523(a)(2)(A) of the Bankruptcy Code.)

This is an important exception to discharge because it could apply to many different kinds of debts. The other exceptions to discharge apply to very specific categories of debts. For example, these other exceptions include child and spousal support, various taxes, and student loans. But the fraud exception could apply to just about any debt if it was incurred in a fraudulent way.

What Makes for a Fraudulent Debt?

Your creditor would have to demonstrate that its debt should not be discharged because you incurred that debt fraudulently. If the creditor fails to do so the debt WILL get discharged and you’ll no longer legally owe it.  

To avoid discharge of the debt, the creditor would have to present evidence and prove EACH of the following:

  1. you made a representation
  2. which you knew at THAT time was false
  3. you made that representation for the purpose of deceiving the creditor
  4. the creditor relied on this representation
  5. the creditor was damage by your representation.

For example:

  1. a person gets a loan by representing that he or she has a certain amount of income
  2. while knowing that income amount was inaccurate
  3. with the purpose of fooling the creditor into making the loan
  4. resulting in the creditor relying on this income information in making the loan
  5. and losing money when the person didn’t pay back the loan

What Happens When a Creditor Alleges Fraud

Proving all five of these necessary elements often isn’t easy. So creditors tend not to object unless they believe they have a strong evidence of fraud. In the vast majority of consumer bankruptcy cases no creditors raise any fraud-based challenges.

When a creditor does raise such a challenge it does so in a specialized lawsuit in the bankruptcy court. This “adversary proceeding” usually focuses directly on whether the creditor can prove the five elements of fraud.

Such adversary proceedings almost always get settled. That’s because the amount of money at issue doesn’t justify the expense in attorney fees and other costs that can accrue quickly for both sides.  

Staying Allegedly Fraudulent Debts

The “automatic stay” imposed against virtually all creditor collection action also applies to allegedly fraudulent debts. If the creditor has alleged fraud prior to your bankruptcy filing, the filing will at least temporarily stop all collection on the debt. The “automatic stay” stops “any act to collect, assess, or recover a claim against the debtor.”  (Section 362(a)(6) of the U.S. Bankruptcy Code.)

Then, as mentioned above, the debt will either get discharged or not. If the creditor doesn’t file an adversary proceeding in time, the debt DOES get discharged. If the creditor files an adversary proceeding but then doesn’t prove fraud, the debt is discharged.

On the other hand, if the creditor does prove fraud the debt is not discharged and the creditor can then pursue the debt. It gets a judgment stating that the debt is not discharged and collectible. Then the creditor can use all the usual collection methods to collect the debt.  

However, because these matters are usually settled, the settlement usually includes an agreed payment plan. So in the unlikely event that a creditor DOES allege fraud against you, files a timely adversary proceeding, AND convinces the bankruptcy judge that all the elements of fraud were present, you would still very likely have a workable way to pay the debt without worrying about being hit by unexpected collection actions.

 

Two More Creditor Challenges to the Automatic Stay

February 23rd, 2018 at 8:00 am

A creditor might want to pay a claim through your insurance, or finish a lawsuit to establish that you got the debt through fraud.  

 

“Relief from the Automatic Stay”

Our last blog post got into some reasons that creditors ask for “relief from stay” other than to repossess collateral.

The “automatic stay” is one of the biggest benefits you get for filing bankruptcy. It “stays”—legally stops—virtually all creditor collection actions right away when you file a bankruptcy case. The automatic stay protects you, your assets, and your income from creditors. It does so permanently in many circumstances.

But there are exceptions, when creditors can ask for permission to pursue a debt, and may get that permission.  So it’s important to know the circumstances in which a creditor would be able to get “relief from stay.”

Last time we explained two of those circumstances, allowing a creditor to finish a legal proceeding against you to determine whether you are liable on a debt, and if so how much you owe. Now here are two other circumstances where creditors may get “relief from stay.”

1. Getting Paid Insurance Proceeds  

When you file bankruptcy you get protection from creditors to which you are personally liable on a debt. But what if your liability is completely covered by insurance, such as with a vehicle accident? Or what if insurance would at least partially cover the amount of your liability?  

The money to pay the claim is not coming from your pocket but that of your insurance company. Should your bankruptcy filing affect your insurance company’s obligation to pay your liability up to the coverage limits?  Arguably not. An injured person may understandably believe your insurance company should pay your liability regardless of your bankruptcy filing.

But the person allegedly damaged by you can’t pursue you, your assets, or your income because of the automatic stay. However, he or she could file a motion asking the bankruptcy court for permission to pursue ONLY the insurance proceeds. The motion would make clear that the debt would be pursued only against your insurance coverage.  Assuming that the court would agree, it would sign an order granting “relief from stay” for the person to go after your insurance proceeds, but not against you in any other way.

Note that your insurance company likely has a “duty to defend” you in such a situation. So the insurance company and the allegedly damaged person, or their respective lawyers, would likely negotiate the matter. Most likely there would be no lawsuit. Or, if there would be one it would get settled and not go to trial. In the unlikely event that it would go to trial, your insurance company would pay to defend the lawsuit, and would pay out any damages up to the coverage limit. Any damages beyond coverage limits would very likely be written off—discharged in bankruptcy.

2. Determining Dischargeability of the Debt

Most types of debts can be discharged in bankruptcy. But there are quite a few exceptions. Some examples of exceptions are criminal debts, unpaid spousal and child support, recent income taxes, and many student loans. See Subsections 523(a)(1),(5),(8), (13), and (15) of the U.S. Bankruptcy Code.

But more conventional debts may also not get discharged based on how you incurred them. A debt incurred through fraud or misrepresentation usually can’t be discharged. See Subsections 523(a)(2) and (4) of the Bankruptcy Code. However, unlike the above exceptions of criminal and support debt, fraud-based debt IS discharged unless the creditor proves the fraud. Then if the creditor would allege fraud, you’d have the opportunity to dispute it.

The bankruptcy court usually decides such fraud-related disputes. But what if at the time of your bankruptcy filing there’s already a state court lawsuit addressing that question?

Just as with the insurance-based circumstance above, your bankruptcy filing would stop that lawsuit from proceeding. But then the creditor could ask for relief from stay to allow the lawsuit to go ahead.

The bankruptcy court might allow the state court to finish deciding whether the debt was incurred through fraud. Or the bankruptcy court might want to decide that issue itself.  Likely it would focus is which court would be more efficient than deciding this issue. And that would likely turn mostly on whether the state court was actually deciding the fraud issue (and not just whether you were merely liable in the debt) and on how close the state court was to a resolution.

 

Timing: Avoiding “Fraudulent Transfers”

October 4th, 2017 at 7:00 am

Giving a gift, or selling for less than true value, can cause problems when done before bankruptcy, but usually only if the amount is large. 

 

“Fraudulent Transfers” Are Uncommon

So-called “fraudulent transfers” do not come up in most consumer or small business bankruptcy cases. But they can sneak up on you. And if one does, it can be a real headache. So it’s important to know what it is, its crucial timing factors, and how to avoid it.

What’s a “Fraudulent Transfer”?

A fraudulent transfer is a reflection of human nature. If someone in financial trouble has an asset or money she wants to keep from her creditors she may be tempted to give it to someone so the creditors can’t reach it. Or she may be tempted to sell it for lots less than its worth.

The gift or sale may be to someone who would give it back later. Or the gift or sale may be to a friend or relative, keeping it within the debtor’s circle. The point is that the asset would no longer be available for her creditors to seize to pay the debts.

It’s human nature that if you have something valuable and are afraid of losing it, you hide it. You keep it from those who could take it. But that doesn’t mean this impulse is legal or moral. Because it’s an understandable impulse, there have been laws against it for at least 400 years in the English law we inherited.

The Results of a Fraudulent Transfer

So, a fraudulent transfer is a debtor’s giving away of an asset to avoiding paying creditors the value of that asset.

Under both federal and state fraudulent transfer laws if you give away something of value within the last two years, then your creditors could require the person to whom you gave that gift to surrender it to the creditors.

Legal proceedings to undo fraudulent transfers can happen both in state courts and in bankruptcy court. In a bankruptcy case, a bankruptcy trustee acts on behalf of the creditors to undo the transfer.

Actual and Constructive Fraudulent Transfers

There are two kinds of fraudulent transfers, based on either “actual fraud” or “constructive fraud.”

The one based on “actual fraud” happens when a debtor gives a gift or makes a transfer “with actual intent to hinder, delay, or defraud” a particular creditor, or his or her creditors in general. (See Section 548(a)(1)(A) of the Bankruptcy Code.) The debtor is acting with the direct intent to keep the asset or its value away from creditor(s).

Fraudulent transfers based on “constructive fraud” happen in consumer situations most often when a debtor gives a gift or makes a transfer receiving “less than a reasonably equivalent value in exchange,” AND the debtor “was insolvent on the date that such transfer was made.  . .  , or became insolvent as a result of such transfer.” (See Section 548(a)(1)(A) of the Bankruptcy Code.) With a constructive fraudulent transfer the debtor does NOT need to intend to defraud anybody. Yet the transfer can be undone if the right conditions are met.

Why Fraudulent Transfers Are Uncommon

There are three practical reasons why most people filing bankruptcy don’t have to worry about fraudulent transfers.

First, most people in financial trouble simply don’t give away their things before filing bankruptcy. They usually need what they have. Plus most of the time everything they do own is protected in bankruptcy through property “exemptions.” So there’s usually no reason to give away or sell anything.

Modest Gifts Are OK

Second, the bankruptcy system doesn’t care about relatively modest gifts. And most people considering bankruptcy don’t have the means to give anything but modest gifts.

By “modest” the bankruptcy system generally means a gift or gifts given over the course of two years to any particular person with a value of more than $600. The Bankruptcy Code does not refer to that threshold amount. But the pertinent official form that you sign “under penalty of perjury” does so.

The Statement of Financial Affairs for Individuals (effective 12/1/15) includes the following question (#13):

Within 2 years before you filed for bankruptcy, did you give any gifts with a total value of more than $600 per person?

The next question (#14) is very similar:                                            

Within 2 years before you filed for bankruptcy, did you give any gifts or contributions with a total value of more than $600 to any charity?

The Trustee Has to Consider Collection Costs

The third practical reason there usually isn’t a fraudulent transfer problem is what it costs the trustee to pursue one. The trustee has to pay attorney fees and other expenses to try to undo a gift or transfer. Or the trustee has to use his or her time or pay staff to do this. So the practical threshold value of the transferred asset is likely many hundreds of dollars. The trustee is not going to pay a lawyer or use his or her time when the likely benefits outweigh the costs.

This is important because there is a question in the Statement of Financial Affairs without a stated threshold dollar amount. This question (#18) asks:

Within 2 years before you filed for bankruptcy, did you sell, trade, or otherwise transfer any property to anyone, other than property transferred in the ordinary course of your business or financial affairs?

Notice the lack of a $600 minimum threshold found in the two questions referred to above. So, every applicable transfer must be listed here regardless of value.  But again, the bankruptcy trustee would likely not do anything about this unless the asset transferred was valuable enough to make the effort to undo the transfer worthwhile.

Caution

The trustee may be more inclined to try to undo a gift or transfer in one situation. If the trustee already has non-exempt (unprotected) assets to liquidate and distribute among the creditors, he or she may be more inclined to pursue a fraudulent transfer. That’s because then the trustee is not risking using his or her own money for the collection costs. The trustee knows there will likely be some money from liquidation of the non-exempt assets to pay those costs.

 

Resolving a Fraudulent Transfer Painlessly through Chapter 13

May 5th, 2017 at 7:00 am

If you owe “priority” debts like income taxes and/or support payments, you may be able to pay no more to protect a transferee. 

 

Let’s follow up on something we said in our last blog post two days ago. We showed how you can use a Chapter 13 “adjustment of debts” case to resolve a fraudulent transfer. Essentially, you pay extra into your Chapter 13 payment plan to make up for doing the fraudulent transfer. In the example we used, the debtor would pay a $225/month plan payment for about 22 extra months to make up for the $5,000 vehicle he or she’d had given away a year before filing bankruptcy.

But we ended that blog post by saying that under certain circumstances the results may be better. We show you how today.

Turning Lemons into Lemonade

Chapter 13 has a knack for solving two financial problems by setting them off against each other.

The first problem: the fraudulent transfer. You gave your friend your spare car a year ago because she desperately needed reliable transportation to commute to work. She now still needs it just as badly, so you don’t want a bankruptcy trustee to take it from her.

If you were insolvent at the time you gave it to her, the car could be taken under Chapter 7 “straight bankruptcy.” “Insolvent” simply means that you owed more in debts than you owned in assets. Then it wouldn’t matter that you gave her the car without any bad intentions towards your creditors.

So the solution we presented was to pay extra into your Chapter 13 plan to make up the difference. You in effect pay for the fraudulent conveyance. You double your generosity to your friend. After giving her the car earlier, you now pay its value over time so your friend can keep it. And you stay longer in your Chapter 13 case, delaying your fresh start. That’s awfully generous to your friend. Maybe too generous!

The second problem: you owe income taxes, or are behind in child or spousal support. Or you are behind on your mortgage and/or property taxes. Any and all of these problems could surprisingly help solve your fraudulent transfer problem.

How Owing Taxes/Support/Mortgage Payments Can Actually Help

Let’s say you owe $6,000 for 2016 federal income taxes and are behind $3,000 on child support. Neither can be written off in bankruptcy. These are also so-called “priority” debts, which must be paid in full in bankruptcy before anything goes to other debts.  

Let’s also say that you are $4,000 behind on your mortgage payments. Under Chapter 13 you are generally allowed to catch up on your mortgage before having to pay other debts.

These three special debts total $13,000. Assume you also owe an additional $75,000 in other debts: medical bills, credit and store cards, and personal loans.

Using the example used in the first paragraph above, let’s assume that you can afford to pay $225 per month into your Chapter 13 plan. Your income obligates you to do that for a minimum of 3 years, a maximum of 5 years. To pay the $13,000 at $225 per month will take nearly 58 months. (This excludes administrative expenses like trustee and lawyer fees, to simplify the calculations.)

This would leave nothing for the remaining $75,000 of debts. That means that those “general unsecured” debts would receive nothing—0%. In most bankruptcy courts that is allowed, as long as you genuinely can’t afford to pay any more than $225 per month.  

How This Solves the Fraudulent Transfer Problem

Chapter 13 law requires you to pay into your plan all that you can afford to pay for a certain length of time. For certain incomes it’s 3 years; for larger amounts it’s 5 years. Here we are assuming that the 3-year minimum applies.

In our example you are paying beyond the 3-year minimum in order to pay the three special debts. (The income tax, child support, and mortgage arrearage.) You can do so if you are indeed paying all you can afford, and finish within 5 years.

The Chapter 13 trustee will generally agree not to pursue the vehicle given through a fraudulent transfer if you agree to pay $5,000 beyond what you are legally obligated. That is what you are effectively doing here. You are legally obligated to pay for three years. However, you are paying nearly two extra years at $225 per month, essentially $5,000 extra. The fact that all this money is going to special debts—ones that you need and want to be paid—makes no difference.

The end result is that you kill two birds with one stone. You pay debts that must be paid (while being protected from their creditors).  You pay an “extra” $5,000 beyond the first 3 years, but that’s money you’d have to pay anyway. So those 4th and 5th years of payments both finishes what you need to pay to your special debts and prevents the trustee from chasing your friend for the car you gave her a year before filing.

Conclusion

The facts used in the example are no doubt different than your facts. And your facts may not fit so neatly into the lesson we are presenting. But the point is to show the possibilities. The point is also to show that the tactics involved tend to be quite sophisticated, especially when dealing with a complication like a fraudulent transfer. It should be very clear that the best solution for you will come through the counsel of an experienced bankruptcy lawyer.  

 

Preventing Avoidance of Fraudulent Transfers through Chapter 13

May 3rd, 2017 at 7:00 am

Overall, Chapter 13 can be more powerful and more flexible than Chapter 7. That often also applies to a fraudulent transfer. 

 

The Problem

Our last four blog posts have been about so-called fraudulent transfers. Today we look at a way to possibly avoid the hassles caused by a fraudulent transfer.

A fraudulent transfer is a sale or gift of an asset you made during the two years before filing bankruptcy case, a sale or gift  that can be undone (“avoided”) during your case. (See our post of Monday of last week introducing fraudulent transfers.)

Consider this example. A year before filing bankruptcy you gave a friend a second car you didn’t need and she desperately did. Now a year later, there is a good chance that your bankruptcy trustee could make her surrender that car. Under certain conditions the trustee would take it, sell it, and pay the proceeds to your creditors.

Your direct intention when you gave her the car a year ago could have been to keep that car from your creditors. Or you could have given her the car with no such intent, but instead only wanting to help your friend. However, even without any intent to hinder your creditors, the gift could be a trustee-avoidable fraudulent transfer.

Depending on your relationship to the person to whom you gave the car, you may not care what happens. But let’s assume you do care—a lot. She REALLY needs that car. You very much do not want a bankruptcy trustee to take it from her. You need to file bankruptcy to fix your financial situation, but you don’t want to risk her losing the car. You’re willing to do whatever is reasonable to resolve this problem.

Chapter 13 in General

One possible solution is to file a Chapter 13 “adjustment of debts” instead of a Chapter 7 “straight bankruptcy.” This is not the place to compare these two very different options in detail. Do that with your bankruptcy lawyer, if you haven’t already. If you’ve seen a lawyer and didn’t hear much about Chapter 13, it may be worth asking him or her specifically about it.

In general, Chapter 13 involves a payment plan spanning a period of three to five years. Before you decide that’s not right for you, be aware that it’s often much better than you’d expect. Chapter 13 provides significant advantages with many kinds of debts and certain asset situations. It is also usually better in solving the fraudulent transfer problem outlined above.

Paying to Protect Your Transferee

Chapter 13 is better with fraudulent transfers because it gives you more leverage and more flexibility.

Let’s use the example outlined above about the car you gave to a friend a year before you filed bankruptcy. Assume the car is worth $5,000. Assume also that if you filed a Chapter 7 case you giving away that car would qualify as a fraudulent transfer. The bankruptcy trustee would be able to take that car from your friend, sell it, and distribute the proceeds among your creditors.

How would that be different in a Chapter 13 case? Assume that under your budget you could afford to pay $225 per month to all of your creditors. Assume also that based on your income you would be required to pay into your plan for three years. So normally you’d pay $225 per month for three years.

But you really want to protect your friend and enable her to keep the car. Most Chapter 13 trustees would likely allow her to keep the car if you paid extra into your payment plan to make up for the money that selling the car would have gotten to your creditors. In our example you could continue paying the $225 per month beyond the required three years until you paid an additional $5,000. That would take about 22 extra months.  (We’re simplifying the calculations a bit by skipping some complicating details like trustee fees.)

The end result is that the trustee gets that extra $5,000 through payments from you instead of by selling your friend’s car.

Caution

The Bankruptcy Code that governs Chapter 13 cases is the same federal codified law all over the country. But bankruptcy judges and appeals courts, and even individual trustees, interpret these statutes differently. So, in your part of the country you may not be able to use Chapter 13 as outlined here. On the other hand, in certain circumstances the results may be even better. So talk with your local bankruptcy lawyer to find out what’s available with your court and trustee.

 

Are Charitable Gifts Fraudulent Transfers?

May 1st, 2017 at 7:00 am

Charitable donations made during the two years before filing bankruptcy may fall within a safe haven of not being fraudulent transfers.

The Quick Answer

To answer the question in the title directly, charitable gifts you make before filing bankruptcy COULD be fraudulent transfers. But they are not if they fit within a significant but limited exception that Congress has carved out for legitimate charities.

A Very Helpful Exception

This is important. Your bankruptcy trustee has the power, under many circumstances, to require someone you gave a gift to within the two years before filing bankruptcy to return the gift, not to you but to the trustee for distribution to your creditors. Imagine a friend, relative, your church, or other charity being ordered to return whatever money or goods you donated! Instead of your good intentions being realized, that money is used to pay the debts you’d hoped to write off.

Our last three blog posts discussed fraudulent transfers, including innocent ones. Generally, giving away something and get nothing, and do so while you’re insolvent (owe more than you own), that’s a fraudulent transfer.  The trustee can force the recipient to return the gift, but not if the gift qualifies for the charitable contributions exception.

The Elements of the Exception

To qualify for this exception the gift must:

  • consist of cash or financial instruments (stocks, bonds, options, and such)
  • be made by a “natural person”
  • be given to a “qualified religious or charitable entity or organization” under certain provisions of the Internal Revenue Code
  • either be not more than 15% of the debtor’s gross annual income during the year of the gift(s), OR, if more than that, “the transfer was consistent with the practices of the debtor in making charitable contributions.”

See Section 548, subsections (a)(2) and (d)(3) and (4) of the Bankruptcy Code.

These elements are mostly self-explanatory but are worthy a bit more explanation.

Cash and Gifts

When you think of donating assets, you may not immediately think of cash contributions. But cash or money in your checking account are certainly assets. They can be the stuff of a fraudulent transfer like any other asset. So cash contributions need to fit this exception to prevent the bankruptcy trustee from going after them.

The Statement of Financial Affairs is one of the main documents you and your bankruptcy lawyer prepare and file. Its question 13 asks: “Within 2 years before you filed for bankruptcy, did you give any gifts with a total value of more than $600 per person?” Its question 14 asks the same about “gifts or contributions” “to any charity?” If you answer “yes” to either one you need to provide details like the recipient’s or charity’s name and address, what and when you gave, and the value. So, cash and gifts are fully covered.

Natural Persons

This charitable contributions exception only applies to people, not to corporations or other business entities.

However, if you own a sole proprietorship that is not a separate legal entity and can’t file its own bankruptcy. Your business and personal debts and assets are all together, not legally distinct. So, the business’ charitable contributions are effectively contributions by you, a qualifying natural person.

Qualified Religious or Charitable Organization

Money given to help support a friend or a relative, one to whom you owe no legal obligation of support, does not qualify.

Nevertheless, frankly, practicalities may very well prevent a trustee from bothering to pursue such a friend or relative. The person may be very difficult to collect from if the money is gone and he or she is insolvent. A trustee has to seriously consider what it would cost to collect the money and the risk of never collecting. Often the money is not worth pursuing.

15% or “Consistent with the Practices of the Debtor”

Relatively few people in financial trouble have been lately donating anywhere close to 15% of their gross annual income to charity.  And even in the rare circumstances when they do donate more, those donations still qualify if making such donations reflected the debtor’s charitable giving practices.  Except in very unusual circumstances would this element disqualify any charitable donations from the exception.

Conclusion

Most payments in cash and financial instruments to genuine charitable organizations will not be fraudulent transfers. However, if you’ve made any significant charitable contributions in the last two years, review them carefully with your bankruptcy lawyer. Given the very awkward consequences if they don’t qualify for the exception, you want to make sure.

 

Fraudulent Transfers without the Actual Intent to Defraud

April 28th, 2017 at 7:00 am

Selling or giving away something innocently, without trying to hurt your creditors, could still give the trustee the right to get it back.

 

“Fraudulent Transfers” without Bad Intentions

It’s confusing: so-called “fraudulent transfers” don’t have to be fraudulent. They can be innocent of any bad intentions by you, the debtor.

In our last blog post we got into “fraudulent transfers” that DO come with bad intentions. Those involve the giving away or sales of assets WITH the “actual intent to hinder, delay, or defraud” creditors. (Section 548(a)(1)(a) of U.S. Bankruptcy Code.) Basically, we’re talking here about hiding or disposing of assets to prevent the paying of debts. “Fraudulent transfer” law allows the bankruptcy trustee to undo, or “avoid,” that gift or sale. The person who got the asset from the debtor before bankruptcy has to give it to the trustee, and then to be distributed to the debtor’s creditors in bankruptcy.

It’s understandable why assets that were fraudulently hidden from creditors should be made available to them. But should same thing happen when the sale or gift was innocent of any bad intentions towards creditors?  The law says “yes,” under certain circumstances. Today we get into those circumstances.

The Two Main Conditions for “Constructive Fraudulent Transfer”

Let’s say you have a second vehicle that you don’t need. So a year before filing bankruptcy you sell that asset and get paid what it’s worth. Then you use the proceeds of that sale to pay living expenses. Selling that vehicle is fine because you got fair market value for that vehicle.

Or let’s say you have that vehicle, but now you give it to a friend without getting anything for it. But at the time you are and continue to be solvent: you have more assets than debts. You file bankruptcy a year later because of a serious accident and huge medical bills that made you insolvent. That earlier giving away of the vehicle is fine because of your solvency at the time. You could do whatever you wanted with your assets a year earlier because then you had more assets than debts.

“Less Than Reasonably Equivalent Value” and “Insolvent”

But now let’s say you didn’t get anything for the vehicle at the time you were already insolvent. You weren’t intending to prevent your creditors from getting at the vehicle. You made no connection in your mind between that vehicle and your debts. You were just helping your good friend who needed a reliable car to get to work. Then you file bankruptcy a year later. That giving away of the vehicle is likely a constructive fraudulent transfer.

The law essentially says that regardless of your intentions, you shouldn’t be giving away assets when you have more debts than you have assets. The law says you should know better. And regardless of your intentions, your creditors should later be able to get at the value of that given-away vehicle. In bankruptcy, the trustee, standing in for the creditors, may well have a right to get that vehicle from your friend, sell it, and pay the proceeds to your creditors.

 

Fraudulent Transfers with Actual Intent to Defraud

April 26th, 2017 at 7:00 am

Selling or giving away something to prevent your creditors from getting it may make a certain amount of sense but could be very dangerous. 

 

Good and Bad Intentions

Last time we introduced “fraudulent transfers.”  We said that in spite of how the term sounds, a fraudulent transfer does not necessarily happen with bad intentions. You could innocently sell or give something away during the two years before filing bankruptcy. That could still be a fraudulent transfer, as long as that sale or gift satisfied a number of conditions.

However, a fraudulent transfer CAN come with bad intentions. Today we cover those made “with actual intent to hinder, delay, or defraud” creditors. (Section 548(a)(1)(a) of U.S. Bankruptcy Code.)

Hiding Assets from Creditors

We can generally agree that in normal circumstances legally owed debts ought to be paid. The law backs this up with legally established procedures for collecting debts. Some of those procedures are centuries old. The law of fraudulent transfers is one of those. It goes was back to the Fraudulent Conveyances Act of 1571 in England, nearly 450 years ago.

A fraudulent transfer is basically a debtor’s selling or giving away of an asset to prevent a creditor from using it to get paid. When done with actual intent, it typically involves a debtor who gives away assets—or sells them for a very low price—as part of a scheme to leave himself with nothing to pay his creditors.

“Avoidable” by the Bankruptcy Trustee

The remedy for a fraudulent transfer involves undoing the transfer, selling the asset transferred, and using the sale proceeds to pay debts of the person involved in the fraudulent transfer.

This can happen outside a bankruptcy case. Most states have fraudulent transfer laws that allow creditors to undo a transfer when certain conditions are met.

But in bankruptcy cases the bankruptcy trustee acts on behalf of all the creditors. If the trustee succeeds in “avoiding” the transfer, he or she sells the asset and pays the creditors according to a detailed priority arrangement laid out in the federal bankruptcy law.

“Transfer”

We have been referring to sales or gifts of assets, but the term “transfer” is very broad. It includes, among others:

each mode, direct or indirect, absolute or conditional, voluntary or involuntary, of disposing of or parting with—(i) property; or (ii) an interest in property.

A transfer can also consist of the creation of a lien on an asset. (See Section 101(54) of the Bankruptcy Code for the meaning of “transfer.”)

Examples

To make better practical sense of this, here are a couple examples of fraudulent transfers done with actual intent.

A year ago you had two free and clear vehicles in your name. You learned that under the laws within your state you could “exempt,” or protect, only one based on their value. So to keep it away from your creditors, you signed one vehicle over to your 22-year old son. He didn’t pay anything for it. You’ve now filed a Chapter 7 bankruptcy to discharge all of your debts. The transfer of the vehicle’s title was an intentional act to prevent your creditors from being paid. The bankruptcy trustee would likely have the right to require your son to give him or her possession and title of the vehicle. The trustee would then sell it and pay the proceeds to your creditors.

You and your two siblings inherited a beach house from your parents. You have serious debt problems. You don’t want your share of this property to go to your creditors. So you and your siblings put the property into a family trust. When you file bankruptcy 18 months later, this transfer intended to prevent your creditors from being paid could be considered a fraudulent transfer. Your siblings would likely have the right to pay the trustee for your share of the property. Otherwise, the property might need to be sold to give the trustee the value of your share.

Conclusion

While it’s understandable that you would want to protect something from your creditors, it’s clearly dangerous to try to do so without legal advice. There are often ways of meeting your goals in a legal way. The asset in question may be “exempt” and already protected. It may make sense to sell it and use the proceeds in a legally appropriate way. You may well be able to protect it through a Chapter 13 case. There can be any of a number of practical solutions. Discuss the situation thoroughly with your bankruptcy lawyer, before you make the transfer. You are much more likely to meet your goals and avoid the headaches of a fraudulent transfer.

 

Introducing Fraudulent Transfers

April 24th, 2017 at 7:00 am

“Fraudulent transfers” have similarities to “preferences.” They are both worth understanding because they can cause unnecessary hassles.  


Asset Timing in Bankruptcy

Your Chapter 7 trustee usually mostly focuses attention on determining whether any of your assets are not “exempt.” You get to keep all exempt assets. If there are any assets that are not exempt, the trustee has the right to take them, liquidate them, and pay the proceeds to your creditors. However, in most consumer Chapter 7 cases all the assets are exempt so the trustee takes nothing. The debtor gets to keep everything.

In this process, the trustee is only interested in what you own at the moment you file your bankruptcy case. This timing gets quite precise. For example, what counts is the amount of actual cash you have on hand at that moment of bankruptcy filing. Same thing with the balance in your checking account(s) at that moment, and all your other assets. The amount of cash or money in your accounts the day before or the day after usually doesn’t matter. What matters is what you had at the moment of filing, with these and all your other assets.

Exceptions: “Preferences” and “Fraudulent Transfers”

This fixation on assets at the moment of filing has a few significant exceptions. We just spent our last six blog posts discussing “preferences.”

The law of preferences allows a bankruptcy trustee to get at something you owned BEFORE filing your Chapter 7 case. That “something you owned” is the money (or some other asset) with which you paid a debt during the 90-day (or sometimes the 1-year) period before filing bankruptcy. See Section 547 of the U.S. Bankruptcy Code. Under limited circumstances the trustee can recapture that payment, requiring the creditor to give that payment to the trustee. The trustee essentially undoes, or “avoids,” that payment. The trustee then uses the money turned over by that one creditor just like any other available debtor asset. The money is paid out to your creditors according to a detailed set of priority rules.

The law of fraudulent transfers is ANOTHER way for a trustee to get at something you owned before your bankruptcy filing. But a fraudulent transfer involves assets you sold or gave away, instead of payments you made to a creditor. The sale or transfer can be to anyone. The look-back time period is much longer—a full two years before filing, and sometimes can be longer. See Section 548 of the U.S. Bankruptcy Code. If the trustee succeeds in undoing, or “avoiding” the transfer, there’s essentially the same result as with any other available debtor asset. The trustee sells that asset and distributes the proceeds according to the same set of priority rules just mentioned above.

Voluntary/Involuntary, Good/Bad Intentions

In the last few blog posts we’ve shown how a preference payment to a creditor can be voluntary or involuntary. That is, you may make that payment freely, with full intention. Or the creditor may force it from you through a garnishment of your paycheck, or some other aggressive collection method. You may be intentionally favoring one creditor over your others, or may have no such intention. All these kinds of payments can qualify as a preference, if they meet some timing and other conditions. The trustee may have a right to “avoid” the payment and make the creditor give up the money.

A so-called fraudulent transfer is one that you do more or less voluntarily. You generally sell or give away your assets by choosing to do so, even if you might wish you didn’t have to. And in spite of the word “fraudulent,” a fraudulent transfer absolutely does not require bad intentions. Innocently selling or giving something away during the two years before filing bankruptcy may be a fraudulent transfer. All it takes is satisfying a number of timing and other conditions.

The Purpose of Fraudulent Transfer Law

This power in bankruptcy to undo a sale or gift is intended to keep the system fair and honest.

By “fair” we mostly mean fair between you and your creditors. Bankruptcy is mostly about debts and assets. In most consumer Chapter 7 cases, all or most of your debts get written off. And you get to keep all of your assets because they are protected, or exempt. But the system still gets to review your assets carefully to determine if you have anything that is not protected, and should be liquidated to pay your creditors. Part of that focus on assets is this power to look back at two years of asset transfers.

But why do “innocent” sales and gifts of assets get included? If the system is trying to discourage keeping assets away from your creditors, if that wasn’t your intention why might your sale or gift still be a fraudulent transfer? It’s because the law in this arena tries to be fair regardless of intention. We’ll show you what this means in the next couple blog posts.

Most Consumer Bankruptcy Cases Have No “Avoidable” Fraudulent Transfers

Let’s keep this all in perspective. There are a number of conditions for a sale or gift to meet to be considered a fraudulent transfer. Most consumer Chapter 7 cases do not involve a trustee trying to undo prior sales or gifts. That’s because in most cases the transfer doesn’t meet the necessary conditions. Or if the conditions are technically met the transfer is not worth for the trustee to “avoid” for practical reasons.

In the upcoming posts we will get into the conditions that create a fraudulent transfer. There are basically two kinds—intentional and unintentional. We’ll start next time with the kind involving the “actual intent to hinder, delay, or defraud” creditors. Section 548(a)(1)(A) of the Bankruptcy Code. 

 

The Judge’s Ruling in a Dischargeability Proceeding: an Example

April 7th, 2017 at 7:00 am

In our example of the adversary proceeding about whether a debt gets discharged, here is the bankruptcy court’s ruling on the matter. 


This is the last of six blog posts in a series showing how a dischargeability dispute gets resolved in bankruptcy court. Check out the last five posts about all the steps in the “adversary proceeding” so far, including the trial itself. In the last one, lawyers for the creditor and the debtor gave their closing arguments. Today the judge announces and explains her ruling.

The Judge’s Opening Remarks

At issue in this adversary proceeding is whether the debtor, Marshall, can discharge his debt to the creditor, Heather. The loan was made five years ago for $35,000; its current balance is about $21,000. The purpose of the loan was for Marshall to start a car repair business. Heather is Marshall’s aunt. At Heather’s request, Marshall completed a loan application and signed a promissory note. As she instructed, after completing and signing these documents Marshall delivered them to Heather’s lawyer. The loan was not secured by any collateral.

For four years Marshall paid the monthly payments on time. But about a year ago there was a fire in the building where his shop was located. He had to shut down his business for a month and replace some of the shop’s equipment. This deeply hurt his business. He stopped the monthly payments to Heather and was eventually forced to close down his shop.

A few weeks ago Marshall filed a Chapter 7 case. Heather responded by filing a complaint asking this court to declare that her debt not be discharged.

Her complaint was based on the allegation that Marshall obtained the loan through fraud. Specifically, she alleged that Marshall lied on his loan application by not listing a $7,500 debt that he owed at the time to another aunt. She argued that under  Section 523(a)(2)(B) of the Bankruptcy Code this omission constituted 1) the “use of a statement in writing” 2) that was “materially false” 3) about his “financial condition” 4) on which Heather had “reasonably relied,” and 5) which Marshall had prepared “with intent to deceive” her.

Marshall admitted allegations #1 and #3. He disputed allegations #2, 4, and 5. Heather had the burden of presenting evidence establishing that that all of these three disputed allegations were more likely true than not true in order for her to prevail.

The Ruling

After carefully listening to and reviewing all of the evidence admitted at trial, I have determined s follows.

First, Marshall prepared the loan application “with intent to deceive” her.

Second, Marshall’s omission of the prior $7,500 debt from Heather’s loan application was clearly false but, under the evidence presented, was not “materially false.”

And third, Heather did not “reasonably rely” on the loan application in deciding whether to make the loan.

The Rationale for “Intent to Deceive”

Marshall rationalized his omission of the outstanding $7,500 debt two ways:

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    • He wanted to avoid Heather potentially deciding not to make the loan to him for what he saw as an irrelevant and irrational reason. He knew Heather could be erratic and unreasonable. He’d heard she was having a personal dispute with his other aunt who had made the earlier loan to him. He understandably didn’t want what he considered totally unrelated to the loan clouding her judgment.
    • Marshall guessed that Heather’s decision about making the loan was based on factors not connected to the loan application. It turns out that he guessed correctly. But at the time he completed the application this was nothing but wishful thinking on his part.  

These rationales may have been understandable and seemingly justifiable. But they do not change the clear fact that Marshall omitted the $7,500 loan with the intent to deceive Heather. And, importantly, his specific intent was to deceive her into making the loan.

The nuance that he was trying to prevent her from being irrational does not matter. The nuance that he hoped she wasn’t actually going to rely on the loan application also does not matter. His entire purpose in making the omission was deceit, deceit calculated to induce her into giving him the money.

So, this court finds that Heather has met her burden of proof as to Marshall’s “intent to deceive” her.

The Rationale for “Material Falsity”

Marshall’s omission on the loan application was clearly false.

The question is whether the omission was materially false. Given that the prior loan was a family loan just like the one Heather was considering may make omitting it more relevant. Given that the $7,500 loan balance was not an insignificant amount also makes its omission appear to be a material one.

However, what determines materiality in this statutory context is a specific objective standard. What is crucial under the law is whether Heather would have still made the loan to Marshall had he listed the prior loan in Heather’s loan application. Whether a falsity is material turns on whether it affected the creditor’s loan-making decision.

Based the evidence (as discussed in more detail in the next section), Heather would clearly have still made the loan if the prior debt had been accurately listed in the application. Since Marshall’s omission would not have made a difference in Heather’s decision, that omission was not materially false.

So, this court finds that Heather has not met her burden of proof as to the “material falsity” of Marshall’s omission.

The Rationale for “Reasonably Rely”

Heather admitted she never looked at the loan application after Marshall completed it. She asked him to deliver it and the signed promissory note to her lawyer without her looking at them beforehand. She did not instruct the lawyer to review the application, inquire into Marshall’s credit record, or do anything else to determine his financial condition. She did not discuss the content of the loan application with her lawyer. She did not rely on the loan application whatsoever. So she could not have reasonably relied on it either.

Heather also affirmatively testified that she based her loan decision on matters of family connection and loyalty. She clearly did not rely, reasonably or not, on the completed loan application.

So, this court finds that Heather has not met her burden of proof as to her “reasonable reliance” on Marshall’s application and the omission contained in it.

Conclusion

Therefore, since Heather has not met her burden of proof as to these last two allegations as required under Section 523(a)(2)(B) of the Bankruptcy Code, Marshall’s debt to her will be discharged in his Chapter 7 case.

 

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