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Introducing Fraudulent Transfers

“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. 


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