By Richard K Gustafson, II

In my last post, I mentioned why it is not a good idea to transfer money to a relative prior to filing bankruptcy. Here is a little more insight into why that is the case.

The bankruptcy trustee has the power to undo transfers of property or payments of money done “in contemplation of bankruptcy.” By using state and federal ‘fraudulent conveyance’ law, a bankruptcy trustee is able to recover property or money paid by a debtor to a third party prior to filing for bankruptcy.

There are several policies behind the enactment of insolvency laws like bankruptcy. One of them was to provide relief to honest debtors, but the other policy considerations focused on the relationship between creditors. Bankruptcy laws would be a way to ensure that similarly situated creditors are treated similarly. This policy eliminates the “rush to courthouse” that exists outside of bankruptcy. If I’m representing a creditor, I want to make sure I’m first in line and that means I have to act quickly to get any money back.

Bankruptcy attempts to even the playing field for all creditors and provide that similarly situated creditors, like various credit card companies, recover the same percentage of their debt as any other similarly situated creditor. For example, if the debtor has $10,000 available to pay creditors, the debtor may want to pay his $10,000 credit card debt owed to Bank A in hopes of maintaining the relationship with Bank A, but that would mean that because Bank A is getting all $10,000, Bank B can’t recover anything.

Bankruptcy, depending on the timing of these payments, gives the bankruptcy trustee the power to recover the payment to Bank A and proportionately divide the $10,000 among both Bank A and Bank B (and any other bank the debtor owes for that matter) ensuring fairness for all creditors.

This same theory allows the trustee to undo payments to family members (the bankruptcy code calls them “insiders”). However, the trustees always scrutinize transactions between family members with a fine tooth comb.

The point here is that if you are in financial distress, get good legal advice before you decide to transfer anything to anyone.

By Richard K Gustafson, II

One of the questions asked of debtors filing for bankruptcy is whether or not he/she has transferred any “money or property” within the last one year. Why does the bankruptcy trustee care about that?

Payments to family members give rise to suspicion that the debtor is attempting to hide assets from creditors by disguising gifts to family members as “loan repayments.” It’s possible someone could give a family member money so it won’t be lost when filing for bankruptcy.

If you have given a family member money, even for a perfectly legitimate reason like paying back money you’ve actually borrowed from them, the person that the trustee will sue to get the money or property back will be the family member you thought you were helping by paying them your money! All you would be accomplishing is getting your family member sued by a bankruptcy trustee, potentially. This would make things worse for you and your family, not better.