Reversing Fraudulent Transfers Before Filing Bankruptcy in San Jose

Reverse a Fraudulent Transfer Before Filing Chapter 7 Bankruptcy in San JoseSeveral weeks ago I posted a piece on this blog outlining what constitutes a “fraudulent transfer” prior to filing bankruptcy and the disastrous consequences such transfers create for the debtor in bankruptcy. Most commonly in the consumer bankruptcy context, a fraudulent transfer occurs when, prior to filing bankruptcy, one transfers an asset to someone else either with actual intent to “hinder, delay, or defraud” her creditors or for less than reasonably equivalent value. Put simply, you can’t give away a valuable asset or sell it at a bargain price before you file for bankruptcy protection. Such transfers are deemed by the Bankruptcy Code to be the equivalent of concealing an asset that would otherwise have been available to help pay your debts.

Although this may strike many as common sense, it is not uncommon that honest debtors make such transfers mistakenly, without getting advice from an experienced bankruptcy attorney, and without even thinking much about it. Take for example an elderly couple who needs to file Chapter 7 bankruptcy in San Jose largely due to medical debts. They recently owned a car but had become unable to drive. Because of their age and medical conditions, they have also recently become unable to live alone, so they moved in with an adult child. They have very few assets, all of which will be exempt in a Chapter 7 bankruptcy. They receive only social security income, and will qualify for a Chapter 7 bankruptcy discharge. However, just a few months before they consider filing for bankruptcy or meeting with a bankruptcy attorney, they gave their car to their adult child, innocently and without giving it much thought at all.

Bankruptcy Code sections 548 and 727 penalize debtors who transfer assets without receiving fair value for them. Section 548 allows a Chapter 7 bankruptcy trustee to sue the recipient of an asset transferred within the last two years prior to the bankruptcy in order to recover the asset for the bankruptcy estate. Section 727 penalizes the bankruptcy debtor by disqualifying him from obtaining a discharge if he transferred an asset within one year prior to filing bankruptcy if he had actual intent to “hinder, delay, or defraud” his creditors.

Fortunately, in the Ninth Circuit, where I practice, the Bankruptcy Court will allow our San Jose couple to reverse their gift of the car to their child. In the case, In re Adeeb, 787 F.2d 1339 (9th Cir.1986), the Court held that for the purposes of fraudulent transfers prior to filing bankruptcy, an asset “must remain transferred at the time the bankruptcy petition is filed.” The Court found that allowing debtors to correct their mistakes prior filing bankruptcy “encourages debtors to reveal transfers and to attempt to recover the property previously transferred. It also gives bankruptcy attorneys who are retained after the debtor has made some mistakes an incentive to see that those mistakes are corrected.”

This means that the elderly San Jose couple of our example, if they get good advice from an experienced bankruptcy attorney, may ask their adult child to return the car back to them before they file Chapter 7 bankruptcy. They should fully disclose in their bankruptcy petition (in the Statement of Financial Affairs) that the transfer took place and was reversed. Otherwise, they would have to wait at least two years (to avoid the trustee suing their child under Section 548) and potentially up to seven years (if the Chapter 7 trustee relies on California fraudulent transfer law pursuant to Bankruptcy Code Section 544). In the case of our elderly couple, they likely do not have the luxury of delaying a bankruptcy filing for so long.

At least in this context, however, the Ninth Circuit has shown a great deal of enlightenment in allowing bankruptcy debtors to correct their mistakes by reversing fraudulent transfers prior to filing bankruptcy. Because this area of bankruptcy law is thorny and full of complicated pitfalls, you should, however, always review the particulars of your situation with an experienced bankruptcy attorney before filing!

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