How Your Bankruptcy Can Harm Your Family If You’re Not Careful

skeleton-20746_640What you did last year may come back to bite your family  when you file bankruptcy.

Even if not fatal, the bite can  leave scars.

I sat waiting for my turn at a bankruptcy hearing last week and watched a series of other cases that left blood in the water.

The trustee’s feeding frenzy in at least three cases centered on payments or transfers the debtor  made to family before they filed their bankruptcy case.

In some cases, the debtor was repaying money lent by family.  In others, it appeared the debtor had simply made a gift to family.

In the worst case, it looked like the debtor had transferred a car to keep it out of the bankruptcy.

All of those transfers spelled trouble.

In each case I watched, the Chapter 7 trustee continued the hearing for the production of documents, the amendment of schedules, or further questioning.

In several, she wanted the debtor to agree to give her a longer period to challenge their very right to a bankruptcy discharge.

None of this bodes well for the debtor.

Here’s why.

The long arm of the law

Bankruptcy law gives the trustee legal rights to recover, for the benefit of creditors, property or money the debtor has transferred.  Collectively, those are the avoiding powers.

Payments on existing debts to ordinary creditors can be recovered from the creditor where the payment was within 90 days of the bankruptcy filing.

If the  payment  was to a family member.  the look back period is  four times as long:  a full year.

So, if you paid on that loan from your sibling or your parent in the year before you file a Chapter 7, the trustee can sue your family member to get the money back.

Why preferences matter

Most people find it hard to understand why payments on genuine debts can trigger trustee lawsuits to retrieve the money.  The debt is real, they say.

It’s not wrong to have paid a real debt.  The idea is fairness among creditors, looking out for the creditors who didn’t get paid back before filing.

It’s also to take the profit, if you wish, out of aggressive collect tactics by some creditors:  no point in levying the debtor’s account if it triggers a bankruptcy filing and a lawsuit to get the money back.

Gifts are worse

In legal speak, a gift is a fraudulent transfer.  The person making the gift didn’t get anything in exchange.

The gift leaves him poorer than he was before.

That’s fine if you have enough remaining to pay your creditors, but not so if the gift damages your creditors.

When the debtor starts giving significant stuff away to family, his later bankruptcy sets those family members up for a lawsuit.

Now, I’ve never seen a bankruptcy trustee try to unwind ordinary birthday gifts or the like.

But start giving away cars, businesses, or houses and things change.  And in California, the look back period for recovering those gifts is four years.

We take care of family

Our desire to take care of those close to us is natural and admirable.

When you’re considering bankruptcy, however,  you need to stifle those caring impulses til after the bankruptcy.

After the bankruptcy, you are free to repay any creditor you wish to.  You can take care of those who took care of you when you needed it without any negative consequences.

Assuming the discharge wiped out all your debts, you can give anything you have away, since no creditor is harmed.

Tell the whole story

As I sat in that hearing room, I wondered whether each of those debtors in the hot seat had told the whole story to their attorney.

Did the bankruptcy papers they filed reveal these transfers, or had the trustee found out some other way?

If the debtors didn’t take full disclosure seriously, they brought trouble on themselves.  Even if the trustee doesn’t sue their family, they may not get a discharge because they concealed the transfer.

The bankruptcy papers you file to start a case ask all the pertinent questions about transfers and payments.  If it was debtor carelessness or deceit that kept the truth out of the record, then I have little sympathy for the debtors.

If, however, the problem was created by lousy lawyering, then I watched the innocent debtors pay.

Lousy lawyering takes several forms,

  • failure to counsel the client fully about the need to be transparent
  • failure to insist on full answers to questions
  • failure to recognize avoidable transfers
  • failure to consider Chapter 13 where family isn’t exposed to suit

This day in court was unusual:  most 341 meetings are dull as dishwater.

But anyone watching this collection of troubled cases was reminded about the benefits of good representation and the importance of telling the whole story.



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