Prospective bankruptcy clients who I meet with are often surprised at how little asset protection planning may be completed in the days, weeks and months prior to an expected bankruptcy filing. The truth is, successful asset planning should be considered long before a financial crisis develops. Although it is often the last thing on a person’s mind during prosperous financial times, asset planning is much more likely to be effective when considered during those good times than after the creditors are beating down the doors.

Bankruptcy Depends on the Good Faith of the Parties
A fundamental concept of bankruptcy is fairness. Bankruptcy courts are courts of equity, and those clients entering the courthouse expecting relief must do so with clean hands. In addition to the more obvious protections available to debtors seeking relief, the bankruptcy code is also full of provisions designed to level the playing field and protect creditors. In particular, the bankruptcy code offers several tools and powers to creditors that seek to collect from debtors who have dissipated, manipulated or otherwise depleted their estates of assets that would otherwise be available to pay those creditors.

In fact, such debtors who attempt to take advantage of the bankruptcy system and proceed in bad faith may face both civil and criminal penalties.

Consider, for example, a hypothetical debtor who gifts his home to his daughter prior to a bankruptcy filing—regardless of whether it is done for seemingly innocent purposes like estate planning or as part of a scheme to defraud creditors. Although such a debtor’s petition in bankruptcy would accurately show no current ownership interest in real estate, the bankruptcy code also requires the completion of a questionnaire called the “statement of financial affairs” that includes more than 25 detailed questions designed to expose any inequitable or nefarious activities of the debtor in the period prior to filing bankruptcy. Depending on the activities involved, the period requiring disclosure can stretch back to as many as 10 years prior to the bankruptcy filing.

The Bankruptcy Process Exposes Fraudulent Activity
Of course if the debtor was unscrupulous in our hypothetical, he may choose to ignore or falsely answer the question on the statement of financial affairs that asks whether any property interest of the debtor has been transferred in the last two years. Such action, however, would result in not only the possible loss of the property to his creditors; the debtor would also be exposed to criminal charges and, if convicted, a lengthy sentence in federal prison.

Even if this hypothetical debtor transferred the property with what he perceived to be innocent intentions and if he properly disclosed it in the statement of financial affairs accompanying his bankruptcy petition, the debtor would still almost certainly face a civil action by the trustee appointed in his case to void the transfer and sell the property for the benefit of his creditors. This is true because the bankruptcy code permits a trustee to void any transfer of a property interest by a debtor within two years of filing a bankruptcy that is made without receiving fair and adequate consideration in return. Depending on the circumstances, the transfer might also expose the debtor to an action by the office of the United States Trustee seeking to deny his overall discharge of debts in the bankruptcy. Not only would this essentially make the bankruptcy filing and the protection from creditors a nullity, such a debtor would still likely end up losing the property he sought to protect. Under the bankruptcy code, any transfers made with the intent to hinder or delay creditors within two years of filing a bankruptcy may result in the denial of the debtor’s entire chapter 7 discharge.

Effective Asset Protection Planning Requires Careful Legal Advice
Aggressive asset planning on the eve of bankruptcy exposes the debtor to great risk with respect to criminal prosecution and the loss of the very assets he or she may be trying to protect. Legitimate asset planning in anticipation of a bankruptcy should instead focus on maximizing the debtor’s exemptions to ensure that he or she is able to protect the specific items of property that the bankruptcy code and state law intend to be beyond the reach of creditors. In some cases, this is as simple as properly electing and applying the available exemptions to ensure that those exemptions are correctly perfected.

It may also include delaying the filing of a bankruptcy in order to properly and appropriately spend down certain assets to a point where they may be exempted. In some cases, with full disclosure to the court, a debtor may successfully convert some non-exempt assets, such as cash, to traditionally exempt property, such as household goods and furnishings, firearms, vehicles, and prepaid funeral policies. The latter options involve careful advice and oversight to ensure disclosure and the effective use of exemptions since many of those exempt categories of items are limited in amount and type.

The expression “pigs get fed and hogs get slaughtered” may be more appropriate in bankruptcy than in any other discipline of the law. Careful, limited and fully disclosed efforts to maximize exempt property prior to a bankruptcy filing not only benefit the client but also serve the purpose of ensuring that the debtor emerges from the bankruptcy not penniless and destitute, but with a sufficient level of assets, tools and other means to take full advantage of the fresh start that he or she has achieved through the discharge of indebtedness. However, those who attempt to defraud the court or their creditors by undertaking false, inequitable or excessive actions to place their assets out of the reach of their creditors may face the sanctions and penalties of not only the bankruptcy code but also its related criminal statutes.

By David Cox,
Bankruptcy Attorney, Cox Law Group, PLLC