To discourage disposing of assets before bankruptcy, a trustee can potentially undo a prior transaction in order to benefit all creditors.
Here’s the sentence that we’re exploring today:
Because the bankruptcy process really cares about assets, if you sell, transfer or gift an asset during a certain period of time before filing bankruptcy, that transaction may be a “fraudulent transfer,” with the result that the bankruptcy trustee may “avoid” (undo) that transaction, whether there was or there was not anything fraudulent about it.
Bankruptcy is about fairness between debtors and creditors. Part of that fairness is about debtors’ assets. Debtors are allowed to keep all “exempt” assets they own as of the time their bankruptcy case is filed. Assets that are not “exempt”—if any—are sold by the trustee and the proceeds paid to creditors towards the debts owed.
Accordingly, bankruptcy fairness has come to mean that if a debtor has an asset that he or she transfers away during a certain period of time BEFORE filing bankruptcy, thus preventing that asset from later being sold by the trustee and its proceeds distributed among creditors, the trustee would be able to undo that “fraudulent transfer” of the asset, and sell and distribute it after all.
Bankruptcy Focuses on Assets
When you file a bankruptcy case everything you own at that moment in time comes under the jurisdiction of the bankruptcy court. The law has to pick a point in time—when your case is filed—to look at your financial situation, especially at what assets you own at that time.
This practical need to focus on the date of filing for asset purposes has a twist designed to discourage debtors from giving away their assets or selling them for less than fair value in order to prevent them going to creditors. This twist is the concept of “fraudulent transfers.”
“Avoidable” “Fraudulent Transfers”
Under certain circumstances the bankruptcy court has jurisdiction not only over assets that the debtor owns when the case is filed but also over assets previously owned by the debtor but sold or given away during a period of time before the filing date. The practical purpose for this is, as just mentioned, to discourage debtors from disposing of assets before filing bankruptcy.
So the law provides that under certain circumstances if a debtor transfers an asset during the two years before the bankruptcy filing, that transfer can be undone—“avoided.” As a result, the transferred asset reverts back to the debtor, the individual or business filing bankruptcy. Then the bankruptcy trustee can sell the assets and distribute the proceeds of sale to the creditors.
Intentional “Fraudulent Transfers”
One kind of “fraudulent transfer” involves assets sold or given away “with actual intent to hinder, delay, or defraud” the debtor’s creditors. The debtor is purposely hiding assets from its creditors. That’s called an intentionally fraudulent transfer. These are not common.
Constructive “Fraudulent Transfers”
A constructively “fraudulent transfer” occurs when the debtor filing bankruptcy simply gets ‘less than a reasonably equivalent value in exchange for such transfer or obligation.” There isn’t necessarily any evidence that this was done to hide anything from the creditors, but the debtor didn’t get paid what the asset being transferred was worth. The transfer was either a gift—in which the debtor received no consideration at all—or a sale for less than full value. Constructive “fraudulent transfers” are presumably much more common than intentional ones.
So under certain very specific circumstances of financial exposure laid out in “fraudulent transfer” law, if a debtor transfers an asset without getting paid adequately for it—in money or for some other fair exchange—and files bankruptcy within two years thereafter, the bankruptcy trustee can undo that transfer and/or get paid the proceeds of the sale of that asset on behalf of the creditors.
In bankruptcy law there are four very specific circumstances in which constructively fraudulent transfers can occur. Detailing all of these is beyond the scope of this already long blog post. But to give you a better idea about this, one of these four circumstances is if the debtor is insolvent when the transfer was made, or the transfer itself made the debtor insolvent. The point is that businesses and individuals should generally be able to sell or gift away their assets without worrying about those sales or gifts being undone in the future. But if that business or individual is selling or giving away assets while it is insolvent, and then ends up filing bankruptcy, then those transfers are seen as having “constructively” defrauded the business’ or individual’s creditors out of the value of that asset.
“Fraudulent transfers” are among the more complicated aspects of bankruptcy. This has been no more than a short introduction. “Fraudulent transfers” are not often involved in consumer cases—more so in small business cases. Either way, one of the benefits of having a highly competent bankruptcy attorney in your corner is that these kinds of potential problems can be discovered, perhaps prevented, and resolved in a way serving your best interests.