A chapter 7 bankruptcy is a liquidation of the debtor's nonexempt assets to pay his unsecured creditors. Hence, many people who are considering a Chapter 7 bankruptcy try to either transfer assets to relatives and friends, or they try to convert nonexempt property to exempt property. However, many of these transfers will be considered fraudulent, in which case, the trustee will get the money back to pay unsecured creditors.
While there are several things that you could do to protect more value in a bankruptcy, it is best to consult with a bankruptcy attorney to determine the best course of action, especially if you may become entitled to receive money or property within 180 days of your filing date from an inheritance, trust, or insurance policy, or from a divorce. The attorney would probably know both the trustee and the judge that will preside over the case, and so the attorney will know better what will be acceptable and what will probably be considered a fraudulent transfer.
Property that has been given away or sold for less than market value right before filing for bankruptcy will probably be considered a fraudulent transfer. You will be required to list all such transfers that have occurred for up to 10 years, depending on what was transferred, in the bankruptcy Form B-7, Statement of Financial Affairs. These transferences include gifts or charitable contributions of significant value that were given within 1 year of filing, and all other transfers that occurred within 2 years of the filing date. Also, all property that was transferred to a trust for your benefit within 10 years of the filing date must also be described.
Some debtors owe money to friends or relatives, or have a loan that was co-signed by a friend or relative. Hence, the debtor is tempted to pay these loans off before filing for bankruptcy. However, it is illegal to do so, since it will be considered a preference, which is an extra payment made to a preferred creditor. The main purpose of a Chapter 7 bankruptcy is to sell your nonexempt assets to pay your unsecured creditors. However, the division must be equal. Therefore, extra payments made to preferred creditors are not permitted. If you have made such payments, the trustee will sue the creditor to get the money back so that it can be evenly distributed.
Specifically, the bankruptcy code states that a preference is any payment or transfer of property with a value of at least $600 to a creditor either within 90 days of the filing date or with 1 year of the filing date if the creditor was your relative, friend, business partner, or a corporation owned by you.
However, you can pay specific creditors after filing with money that is not part of the bankruptcy estate, which includes all money that you earn after filing.
What To Do and What Not To Do Before Filing Chapter 7
If you plan to file Chapter 7 bankruptcy, there are a number of things that you can do to better your position after filing. Because the main purpose of a Chapter 7 bankruptcy is to give you a fresh start and to pay your unsecured creditors with the proceeds of whatever remains of your property after excluding exemptions, it would behoove you to act accordingly. In other words, do everything you need to do to have the fresh start, but don't do things that may lessen the amount that may be left to your unsecured creditors. If you honestly do this, then you will probably not have to worry about having your case dismissed. The trustee or the court may disagree with what you are doing, in which case, they will move to rectify it, but as long as it was an honest mistake, you will probably not suffer sanctions or penalties or a dismissal of your case.
What To Do
The most important thing to do is accurately report all financial transactions of significant value in your bankruptcy petition. Attempting to hide such transactions is strong sign of fraud.
You can also replace nonexempt property with exempt property, but in doing so, make sure that you are not doing it simply to deprive creditors of payment. For instance, vacation property would not be exempt and it is certainly not something that you need for a fresh start. (After all, most people don't have vacation property.) If you sold it for a substantial sum, the trustee will surely want to know what you did with the money. But if you take a nonexempt property such as cash and use it to buy tools of your trade, which are usually exempt at least to a certain amount, then that will probably be all right, as long as the amount spent is not substantial.
What Not To Do
There are a number of things that you shouldn't do, either because it is unwise considering the impending bankruptcy filing or because it may be considered fraudulent.
Don't buy or sell property for anything other than a reasonable market value or what the law calls reasonable equivalent value, especially to relatives or friends. In fact, it would be better not to sell to relatives or friends; instead, use many of the free services offered on the Internet to sell or buy your items, such as Craigslist.org. Doing so will eliminate 1 sign of fraud.
Avoid financial transactions or property transfers of significant value in the few months before your filing date.
Don't pay off a debt that will probably be discharged in your bankruptcy. This not only gives you a better fresh start, but it prevents preference payments.
Don't pay off secured loans, even if they are nonexempt. If your equity in the property is small, then the trustee will not sell the property since the lienholders would have to be paid first, with little left over for your unsecured creditors.
Don't change the form of ownership to thwart creditors. This most commonly concerns property in a state that allows a tenancy by the entirety (TBE) form of ownership. Because all TBE property is exempt for a single filer, some debtors may try to change property that is owned by the filer, either singly or jointly, and convert to a TBE ownership. This will certainly be viewed as fraudulent and will be reversed.
The above is simply an overview, not an exhaustive list. A bankruptcy attorney can help considerably in this area because she not only knows the specific exemptions that are available to you, but also has a good idea of what the trustee or the court will accept and what they may consider suspicious.
Remember, be honest in everything, and you will be much better off. If anything at all seems fraudulent, everything else on your bankruptcy petition will get increased scrutiny.