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Bankruptcy Basics – The Fraudulent Transfer

When an individual is considering filing for bankruptcy, some people may be tempted to try and either transfer property to another or to “rack up” purchases through credit cards prior to filing bankruptcy. After all, all credit card debt is discharged in bankruptcy, right?

The bankruptcy code has a mechanism by which to deal with this kind of debtor behavior, known as “fraudulent transfer.” The doctrine of fraudulent transfer allows a creditor or a bankruptcy trustee to bring a civil action against a debtor when a debtor has acted in such a way as to attempt to hinder, delay or defraud a creditor.

There are two types of fraudulent transfer: actual fraud and constructive fraud. Actual fraud occurs when a debtor transfers property to another individual or entity in an attempt to avoid paying his creditors. Constructive fraud occurs when a debtor transfers property without receiving “reasonably equivalent value” for the property exchanged. In constructive fraud there does not need to be intent to defraud creditors. A common example of this occurs when an individual, in an attempt to avoid any confusion as to who owns the family home, transfers the title to an adult child. Because the transfer occurred without the parents receiving reasonably equivalent value for the home, the property is then reachable for liquidation by the bankruptcy trustee under the doctrine of constructive fraud and is no longer eligible for exemption under the bankruptcy code. Had the parents in this hypothetical situation kept the home while filing for bankruptcy it likely would have been exempt. Unfortunately for our debtors here, unless they are able to pay the trustee either the value of the home, or the sum of their debts, whichever is greater, the trustee will likely sell the home in order to pay creditors.

Another situation, mentioned above, is when an individual who is contemplating bankruptcy decides to make purchases using credit card debt that they believe will soon be discharged in their bankruptcy.  In such cases a court will look to determine what the subjective intent of the debtor was; in other words, whether the debtor intended to incur a debt that they would not pay back.

Courts also look for certain “badges of fraud” in determining whether there was intent to defraud creditors. Badges of fraud include:

·         Becoming insolvent before the transfer

·         Lack or inadequacy of consideration

·         Family, or insider relationships between parties

·         The retention of possession, benefits, or use of property in question

·         The existence or a cumulative effect of a series of transactions after the onset of debtor’s financial difficulties

·         The financial situation of the debtor at the time of transfer or after transfer

·         The existence of the threat of litigation

·         The general chronology of events

·         The secrecy of the transaction in question

·         Deviation from the usual method or course of business

The lesson to be learned from this information is two-fold; first, do not treat bankruptcy as a an opportunity to engage in unethical financial behavior. As a consumer, you should never incur a debt that you know that you will be unable to pay back. Bankruptcy exists to create a workable solution for both debtors and creditors when a person or entity is unable to pay their debts. The second lesson is that if you are experiencing financial difficulty, it is in your best interest to consult with an attorney that understands bankruptcy law. If bankruptcy is an option that would benefit you, only an attorney with experience in this area of law can advise you how best to proceed. The attorneys of The Westbrook Law Group specialize in helping individuals in financial distress get a fresh start through bankruptcy. To schedule a free consultation, call us today at (636) 493-9231, or fill out our contact form on the right side of this page and member of our staff will be in touch with you shortly.