Transfers Preferences Preferential Payments

You may be considering transferring property before filing bankruptcy. If you are thinking of filing bankruptcy do not make any transfers before checking with an attorney. A transfer before bankruptcy can cause you serious problems.

Maybe once per week, I have a conversation with a client or a potential client that goes something like this:

Me: You may have too much property. You might have to sell that car before you file bankruptcy or else the trustee will take it.
Client: “Oh that’s no problem. I’ll just give it to my brother-in-law. I owe him a lot of money anyway.”
Or “I owe my mom $10,000. I’ll just give my mom a lien on the vehicle and that way I won’t have any equity in it and the trustee won’t take it.”

This won’t work. Don’t do it. In fact it will probably result in big problems.

The bankruptcy code allows the bankruptcy trustee to avoid certain transfers. “Avoid” means cancel.

A gift is presumed to be a fraudulent transfer. The transfer will be a void (cancelled) the trustee will take the property from the person you gave it to.

If you sell it for fair market value that’s ok. But if you transfer it to someone because you owe that person money from before the transfer, that’s a problem. (” I’ll just give it to my brother in law. I owe him a lot of money anyway.”)

Section 5476(b) provides that the trustee can avoid such a transfer if
*The transfer was for a debt which existed before you made the transfer.
*You were insolvent (that’s often true if you’re considering bankruptcy)
*The transfer was made within 1 year before filing for bankruptcy in the case of an “insider” such as your brother in law (it’s 90 days for transfers to non insiders).

If you are giving someone a lien on your property that may also be a transfer that the trustee can avoid (cancel).

But there is a safe harbor for lien transfers:

The trustee may not avoid under this section a transfer—
(A) to the extent such security interest secures new value that was—
(i) given at or after the signing of a security agreement that contains a description of such property as collateral;
(ii) given by or on behalf of the secured party under such agreement;
(iii) given to enable the debtor to acquire such property; and
(iv) in fact used by the debtor to acquire such property; and
(B) that is perfected on or before 30 days after the debtor receives possession of such property;

As you can see in order to come within this safe harbor the debt for which you are giving the lien must be to purchase the property. And the lender must perfect the lien (record it with the DMV) within 30 days.

So in the “I owe my mom $10,000. I’ll just give me mom a lien on the vehicle and that way I won’t have any equity in it and the trustee won’t take it.” the transfer of the lien can be avoided.
So what happens if the trustee avoids a transfer?

If the property is not exempt the trustee will take the property, sell it and give the money to the creditors (after taking a percentage for himself.)

If you didn’t list the property in the petition because you think you transferred the property, it won’t be exempt and the trustee will take it. If you listed the property but didn’t list its equity because you thought there was a big lien on it once the trustee avoids the lien he will take the property from you since you did not exempt it.

Another situation I encounter frequently is the payment by a client of a debt shortly before filing bankruptcy. For example a client may pay Mastercard $2500 on March 1 and then we file bankruptcy on April 10.

Why would a client do this? Probably because he thinks that MasterCard will let him keep the account open. Don’t count on it! The credit card company may take the money and close the account anyway.

This may be considered a “preferential transfer”. It is then the trustee can recover the money back from Mastercard and pay it to the creditors.

You may be asking: “What do mean by ‘shortly’ before filing bankruptcy”? In the case of an ordinary creditor like Mastercard the preference period is 90 days, In other words, in the above example, since the client paid the $2,500 to Mastercard less than 90 days from the date he filed bankruptcy the trustee can recover that $2,500 from Mastercard. He will then pay the money to the creditors.

But the 90 day rule applies to ordinary creditors. For insiders (relatives, business partners, affiliates, etc) the period is 1 year.

From time to time a buisness person will ask me if it’s okay to pay a creditor shortly before filing bankruptcy.  For example, a dentist may have an ongoing relationship with a lab to pay for crowns.  The dentist makes regular payments to the lab.  The dentist needs to keep current on the payments or else the patients won’t receive their dental work. The dentist needs to file bankruptcy but also needs to pay the lab.

This is probably okay.

Payments received in the ordinary course of business in accordance with ordinary business terms are not considered preferential. To establish an ordinary course of business payment, you need only show that the payment was made in the ordinary course of your and the creditor’s business, or in accordance with terms common in your particular industry.

What happens if the trustee recovers money from a creditor the debtor paid money to?

There can be a big problem for the debtor.  The debtor can lose the exemption that the debtor would otherwise have.  Let me explain.  Assume the debtor has a car with equity of $6,350.  If the debtor were to file bankruptcy $5,350 would be exempt under the vehicle exemption.  The $1,000 over the vehicle exemption could be exempt under the wild card exemption.  But assume the debtor transferred the vehicle to his brother shortly before bankruptcy.  The trustee could recover the vehicle, sell the vehicle and give the $6,530 to the creditors.  But what about the $5,350?  Doesn’t the debtor get that off the top before the creditors are paid?  The answer is “no”.  Debtor loses the exemption under 11 U.S. Code § 522 (g).

Another problem is that it delays the closure of the case.

First, the trustee makes the claim to the creditor. The creditor may assert a defense. One of the defenses the creditor can assert is that the payment was made in the ordinary course of business or financial affairs between the debtor and the creditor. The trustee may actually sue the creditor and an judge will have to decide the case. This takes time.

If and when the trustee receives the payment from the creditor the trustee notifies all the creditors that there is money to be divided up among the creditors. The trustee then works through the process of paying all the creditor that make their claims on time. This can take months or even a year

What if your client transfers property to someone, innocently and in good faith, and the transferee improves the property?  If the trustee recovers the property does the transferee lose out on all the money he spent improving the property?  If the transfer was in good faith the transferee has the right to be reimbursed and has a lien on the property to secure his right of reimbursement under 550(e).

This is a tricky area. Consult with an attorney before you make a transfer if you are considering bankruptcy.

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