A great question was posed on our Nebraska bankruptcy attorney listserv this morning:

Dear list-mates:  I have a older couple wishing to file bankruptcy who approximately a year ago transferred their house (which qualified then and now as their homestead valued at less than $60k) to their daughter retaining a life estate in themselves. My first instinct was that they don’t have to worry about the trustee trying to avoid the transfer because it was a transfer of exempt property – no harm no foul.  Now I’m wondering whether this will be seen as a constructively fraudulent transfer. The transfer was less than 2 years ago. Was for essentially no value. The debtor was insolvent at the time of the transfer, and certainly would have been as a result of it. There is no mortgage on the house. Any insight is appreciated.

He was right to be concerned about a fraudulent transfer.  Chapter 7 bankruptcy trustees have the power to reclaim property transferred out a debtor’s name that have occurred within four years of filing bankruptcy when property or services of equal value were not transferred back to the debtor.

The Nebraska Uniform Fraudulent Transfer Act states that “[a] transfer made or obligation incurred by a debtor is fraudulent as to a creditor whose claim arose before the transfer was made or the obligation was incurred if the debtor made the transfer or incurred the obligation without receiving a reasonably equivalent value in exchange for the transfer or obligation and the debtor was insolvent at that time or the debtor became insolvent as a result of the transfer or obligation.”

In the above example, the children of the debtor received the home, subject to a life estate in favor of the debtor, without exchanging anything of value.  It was a one-sided gift.  In this case the debtor seems to have transferred the home for Medicaid planning purposes and was not attempting to defraud his creditors, nevertheless the transfer would be deemed a fraudulent transfer since equivalent value was not exchanged.  Had a bankruptcy been filed the Chapter 7 trustee would have taken the children’s interest in the home.

What if a fraudulent transfer has occurred but you still need to file bankruptcy?

  • Reverse the Transfer.  The problem above could be fixed if the children were to convey their interest back tot he debtor prior to filing bankruptcy.  The value of the home was clearly less than the Nebraska homestead exemption protection ($60,000), so the home would have been fully protected if the debtors reversed the transfer.
  • Wait 4 years to file bankruptcy.  Most fraudulent transfers become protected after 4 years, but there are a few dangerous exceptions to this general rule.
  • File Chapter 13 Bankruptcy.  It really should not make a difference whether a chapter 7 or chapter 13 case is filed since unsecured creditors should receive equal treatment, but a key difference between the chapters is that the trustee in a a chapter 13 case does not have the power to go after fraudulent transfers.

Another important factor to consider with fraudulent transfers is that they must be reported on the bankruptcy schedules. Many bankruptcy attorneys wrongly believe that only transfers that occur in the preceding 2 years must be reported, but some courts and the US Trustee’s Office believe that all fraudulent transfers that are voidable must be reported on the asset schedules.

Image courtesy of Flickr and Mark Hillary.