A colleague of mine recently had a potential client come in for an initial consultation about possibly filing a bankruptcy case. This person had, a year and a half earlier, transferred his 50% interest in his family’s home to another family member. His share was worth $250,000 (it was owned free and clear of any liens), but he had received nothing in return for the transfer. He made the transfer because he was worried about his creditors coming after him and taking the house. He now wanted to file a bankruptcy case in order to stop a creditor lawsuit that had been filed in Superior Court.
Unfortunately, my colleague was not able to tell this potential client what he wanted to hear.
Section 727(a)(2) of the Bankruptcy Code states: “The court shall grant the debtor a discharge, unless: … the debtor, with intent to hinder, delay, or defraud a creditor… has transferred… property of the debtor within one year before the date of the filing of the petition.” In other words, if you transfer property in an attempt to evade your creditors (as this person seemed to have done) within a year of filing a Chapter 7 case, the court will deny you a discharge of your debts. In this instance, the transfer had taken place a year and a half earlier, so this provision didn’t come into play, but it was an important consideration.
Section 548(a)(1)(A) of the Bankruptcy Code states: “The trustee may avoid any transfer… of an interest of the debtor in property… that was made within 2 years before the date of the filing of the petition, if the debtor… made such transfer with actual intent to hinder, delay, or defraud an entity to which the debtor was or became indebted.”
Section 548(a)(1)(B)(ii)(I) of the Bankruptcy Code states: “The trustee may avoid any transfer… of an interest of the debtor in property… that was made within 2 years before the date of the filing of the petition, if the debtor… received less than a reasonably equivalent value in exchange of such transfer, and … became insolvent as a result of such transfer.” Section 101(32) of the Code defines “insolvent” as meaning that the sum of your debts exceeds the sum of your assets.
Therefore, if this person filed a Chapter 7 case, a trustee would have two bases for undoing the transaction: First, it was made less than two years earlier and had been made to hinder his creditors. Second, he received less than equivalent value and, since it was his only asset of any real value, he had become insolvent as a result. A Chapter 7 trustee could therefore undo the transfer, making the house property of the bankruptcy estate. It would not be covered by this person’s exemptions, so the trustee would sell the house, give the other family member her 50% share, and then distribute the remaining proceeds to this person’s creditors.
What about a Chapter 13 case? A Chapter 13 trustee does not have the authority to liquidate assets, but Section 1325(a)(4) of the Bankruptcy Code states that “[T]he court shall confirm a [Chapter 13] plan if the value… of property to be distributed [to unsecured creditors] under the plan… is not less than the amount that would be paid… if the estate of the debtor were liquidated under Chapter 7.” In other words, only plans that pay unsecured creditors as much as they would have received in a Chapter 7 case can be confirmed by the court. Therefore, this person could only get a Chapter 13 plan confirmed if it proposed to pay back 100% of his debtload (insofar as that debtload was less than the $250,000 in value he had given away).
My colleague’s advice to this person? Answer the Superior Court Lawsuit. The likelihood of that matter being resolved in less than six months is low. Then, when the 2-year period described in Section 548(a)(1) elapses, come back and revisit the subject of filing a bankruptcy case.