Transferring Property Before Filing Bankruptcy, Without Being Paid For It: How to Fix the Problem, Part One of Two

Occasionally, a person facing debt problems will become concerned that an item of property (real estate, a stock account, or other some other valuable asset) might be vulnerable to a judgment creditor, or that such an item could be taken from him or her in a future bankruptcy case.  Without consulting an attorney, and in a misguided effort to protect the property, the debtor might decide to transfer ownership to a relative, or a trusted friend, without being paid fair value for the item.  The debtor no doubt believes this will shield the property, because if he or no longer owns it, how could it be taken by a creditor or by the bankruptcy trustee?

However, upon consulting with an attorney, the debtor will discover that such transfers of property are ineffective both outside bankruptcy and in a bankruptcy proceeding.  Worse, if done in the one year before a chapter 7 filing, making such a transfer disqualifies the debtor from even receiving a bankruptcy discharge.  The question, then, is what can be done to undo the damage resulting from a transfer of property made without receiving fair value?  Can the debtor still file bankruptcy, and can the property be protected?

In a nonbankruptcy context, the problem arises because in nearly every state, a judgment creditor can avoid (and recover) a transfer of property made by a judgment debtor for which fair value was not paid to the debtor.  Some states require that it also be shown that the motive for the transfer was to evade a creditor’s claims; some states further presume this was the intent if the debtor was insolvent at the time of the transfer.  This means that a transfer of this nature does not help the debtor, unless the creditors of the debtor are too unsophisticated to discover what has happened — an unlikely scenario in most cases involving competent collection attorneys.

In a bankruptcty context, the problem arises under several sections of the bankruptcy code: section 727, which forbids a chapter 7 discharge for a debtor who has transferred property with the intent to hinder, delay or defraud a creditor in the one year before filing; section 548, which allows the trustee to recover transfers made for less than fair consideration in the two years before filing bankruptcy; and sections 1325(a)(3) and (4), which require that chapter 13 plans be filed in “good faith,” and that chapter 13 plans pay creditors at least what they would have received in a hypothetical chapter 7 case.

Thus, for a debtor who has made a suspect transfer of property, simply filing a chapter 7 will likely have the unpleasant result of the trustee obtaining the supposedly transferred property; the trustee will then sell the property to pay creditors; and the debor has his or her discharge denied as well.  A chapter 13 filing under such circumstances may well have similar consequences, including denial of confirmation of the plan and involuntary conversion to chapter 7.

Part Two of this article will discuss the steps a debtor might take in order to repair the damage done by a transfer of property for less than fair consideration.