Filing bankruptcy is usually considered a personal decision. However, if done incorrectly, it can have far reaching ramifications that can sweep your entire family up in its wake. The biggest mistake people make is transferring assets or repaying debts to family members prior to filing bankruptcy. This type of behavior can expose your family to investigation by the bankruptcy trustee. As in all aspects of the law, transparency is key.
Dragged in, unaware
While I was waiting my turn for a bankruptcy hearing a few weeks ago I couldn’t help but overhear the discussion going on between a local attorney (with a bad reputation), their client and the trustee. The trustee had noticed a serious discrepancy in the petition versus the testimony the client gave. As I watched, it unfolded much like a scene from shark week. As the client and his incompetent attorney threw more proverbial “chum” in the water, the trustee became more and more aggressive.
The trustee’s investigation was quickly honing in on transfers the debtor had made to family members before they filed their case. Some of the cases involved repaying debts to their family members while others appeared to just be straight up gifts. The worst part about the whole situation was the “sale” of an RV to a family member that appeared to be a coordinated effort to keep the RV out of bankruptcy.
By the time the trustee was done, he was calling for a horde of documents to be produced, a further examination of the finances of the debtor and appearing to challenge the dischargeability of the debts. In other words, things went off the rails for the debtor very quickly and transparency could have potentially kept things on track.
The long arm of the (bankruptcy) law
The bankruptcy law is there to give debtors who fully disclose their situation a wonderful break to restart their lives. If you’re open and transparent with the trustee, you’ll usually end up coming out smelling like roses.
The law gives the trustee an enormous amount of power to go after property and assets that debtors try to hide from the trustee and their creditors. Bankruptcy seeks to give everyone a fair shake, debtor and creditor. When you try to hide assets, you’re denying creditors their fair shake.
If you make a payment on existing debt to an ordinary creditor, that creditor is subject to a 90 day look back. That means that the trustee can recover anything that is deemed preferential that was paid 90 days before the bankruptcy filing. If the payment was made to a family member, the lookback is a full year.
In other words, if you paid a family member off, the trustee can sue your family member to recover the money you paid them in a chapter 7 bankruptcy.
Most people find it hard to understand why payments on genuine debts can trigger trustee lawsuits to retrieve the money. The debt is real, they say.
A lot of people can’t believe that payments on legitimate debts can trigger the trustee’s pursuit of the payments. The issue isn’t that you’ve paid a real debt. The issue is you prioritize debts. If you’re paying one creditor, be it a family member or your local credit union, but you’re not paying other debts, that’s called a preference. In bankruptcy, preferences are against the law. Every creditor must be treated the same.
Gifts cause problems
Legally speaking, a gift to a family member is called a fraudulent transfer. You’re giving the family member something and getting nothing in return. Technically that leaves you poorer than before and that technically damages your creditors. If you start giving too much stuff away to family members, you’re setting them up to be sued by the trustee to recover those assets
I’ve never seen a bankruptcy trustee try to take back ordinary birthday or Christmas gifts but if you start handing out cars, boats, houses or businesses, you’re probably going to create some issues.
We take care of family
Everyone wants to take care of our family, that’s in our nature. If you’re looking at filing bankruptcy, you need to wait until afterwards to start taking care of your family again. After the bankruptcy you are free to pay back any creditor you want without consequence. In other words, you can take care of those who are taking care of you. Once you get your discharge, you can give anything you have away.
Tell the truth
Transparency is key and my biggest concern as I sat there was, did the debtor tell his attorney everything? Did the attorney not list everything in the petition? Did the trustee find out some other way.
If the debtor didn’t believe his attorney when he was told to disclose everything, they made a terrible decision and brought the trouble on themselves. Even if they don’t end up getting their family sued, they might not get a discharge.
The petition you file asks lots of questions. Many of them seek to find the truth about your finances. They ask about payments to creditors and transfers of property to others. If you don’t tell your attorney what’s going on, we don’t have much sympathy for you.
However, if the problem is created by a crummy lawyer, I have to see innocent debtors face the music.
Crummy Lawyers fail in several ways.
- They fail to explain how serious the issue of transparency is
- They fail to recognize transfers that were avoidable
- They fail to insist that their client fully answer questions
- They fail to consider a Chapter 13 for clients who could potentially expose their family to lawsuits.
This day in court is unusual, so don’t let that scare you. As long as you’re open with me, we’ll find the best course of action for you. Remember, transparency is key.