CHANGING EXEMPT ASSETS INTO NON-EXEMPT ASSETS IN BANKRUPTCY

Debtors sometimes think that they are ‘saving’ an asset so they do an act pre-petition believing that by perpetrating such act they ‘saved’ the asset. ‘Saved’, meaning they will not lose the asset when they file for bankruptcy. There is, of course, malice aforethought here because they are actually thinking of deceiving the bankruptcy court and perpetrating a fraud on the court. These debtors are in fact quite simple-minded and have no idea at all how bankruptcy law works. Instead of ‘saving’ the asset, the effect of the malicious pre-petition act is to ‘loose’ the asset. Let’s discuss two typical pre-petition transactions. I call these typical because I have seen it often enough in my 30 years of practicing bankruptcy law.

PRE-PETITION TRANSFER OF ASSET:
Debtor owns a house with equity of $100,000. Believing that he will ‘lose’ his residence when he files for bankruptcy, he transfers title to a relative without receiving any consideration for the transfer. He continues to live in the house and says that he pays rent to the relative. The relative then uses the rent to pay the mortgage. Relative transferee actually holds the property in trust for debtor. After transferring title to the residence, debtor believes he has ‘saved’ his residence and is now ready to file for bankruptcy. On the contrary, debtor will ‘lose’ his residence when he files for bankruptcy. Why so? Bankruptcy courts can reach back 4 years and invalidate any fraudulent transfers of property designed to cheat creditors. In this case, debtor received nothing for the transfer even though he had $100,000 of equity in the house on the date of transfer, transferred the property to a relative, debtor still lives in the house, and relative holds the property in trust for debtor. All of these circumstances are ‘badges of fraud.’ They are big red flags telling the court that the pre-petition transfer made on the eve of bankruptcy was fraudulent. What happens when debtor files for bankruptcy? Chapter 7 trustee will file an adversarial complaint to annul the pre-petition transfer, on the ground that it was a fraudulent pre-petition transfer. Debtor will have no defense because it was actually a fraudulent transfer designed to cheat his creditors. The court will annul the transfer, take the property back into the bankruptcy estate, authorize trustee to sell the property and use all of the net sale proceeds to pay off debtor’s creditors and trustee’s fees for liquidating asset and trustee’s legal fees. Nothing will be left of the $100,000 equity. Not only will debtor lose his equity, he will have no house to live in. If he is able to exempt his car, he will have to move out of his house and move into his car!

On the other hand, if debtor did not make the pre-petition transfer, he would be able to keep his house by claiming it as exempt homestead under 704.730 which provides a $100,000 exemption for the equity of debtor’s residence. If he did not make the transfer, he would still have his house, still have his equity of $100,000 and would not have to move into his car.

PRE-PETITION CHANGE OF NATURE OF ASSET:
Another typical action by debtor is changing the nature of the asset, thinking he has made a brilliant legal move to save his asset. To illustrate, debtor has a 401K of $50,000 which he believes he will ‘lose’ when he files for bankruptcy. So, he liquidates the 401k and keeps the $50,000 in cash under his mattress. By hiding the money under his mattress, debtor believes he has hidden the money from bankruptcy court. Debtor believes he cannot hide his 401K from the court because his 401K is kept in a bank. Retirement accounts, such as IRA, 401K, 403(b) etc. are exempt up to $1.0 million under the new bankruptcy code. When debtor liquidated his 401K, he changed the nature of the $50,000 from exempt as a retirement account, to non- exempt as ordinary cash.

Lawrence Bautista Yang is a graduate of Georgetown University Law Center and has been in law practice for thirty years. He specializes in bankruptcy, business and civil litigation and has handled more than four thousand successful bankruptcy cases in California. He speaks Mandarin and Fujien and looks forward to discussing your case with you personally. Please call (626) 284-1142 for an appointment at 1000 S Fremont Ave Bldg A-1 Suite 1125 Unit 58 Alhambra, CA 91803.