Was Your Debtor's Bankruptcy Planned
Preventing Discharge and Getting Paid
on Your Unsecured Claim When the Debtor Least Expects It.
By Richard Ruszat
As you may be aware, the Bankruptcy Code presents a unique
opportunity for debtors to avail themselves of a "fresh start." Through
bankruptcy, debtors are able to discharge or manage burdensome
debt and claim limited exemptions for personal and real property.i
Although payment to creditors is also a goal of the Bankruptcy
Code, the fresh start is more often at the expense of unsecured
creditors that realize only pennies on the dollar, if a penny
at all. In the best of worlds, debtors are candid with disclosures
of their finances and assets. In realty, conscientious debtors
are seeking ways to maximize their assets and stretch their exemptions
with a practice known as "bankruptcy planning."
Maximizing Exemptions versus Defrauding Creditors
Although certain bankruptcy planning practices are acceptable,
other practices may prevent the discharge of the debtor's liabilities.ii
Debtors that possess significant assets risk having their assets
collected and liquidated for distribution to creditors. Oftentimes,
these debtors will practice bankruptcy planning to protect their
assets. Although no clear line of demarcation exists, maximizing
exemptions is permissible while a ploy to "hinder, delay or defraud
creditors" will prevent discharge. Generally, acceptable bankruptcy
planning practices include venue and choice of law decisions,
transmutation of a non-exempt asset into an exempt asset, or
use of present cash for payments on debt that will not be discharged
(e.g., secured debt, taxes, and family support) instead of payment
on unsecured lines of credit that are likely to be discharged
in bankruptcy. On the other hand, illegal bankruptcy planning
practices may include acquiring loans to purchase exempt property,
incurring liabilities with an intent to file a bankruptcy petition,
and executing transfers of personal or real property to insiders
or for inadequate consideration. In any event, it is important
to note that courts are variable on acceptable bankruptcy planning
practices. Identification of these practices may result in the
discovery that the debt is not dischargeable.
Getting a Handel on the Estate's Assets
If a debt is not discharged in bankruptcy, then the creditor's
claim survives and the creditor may collect against the full
value of the debt instead of receiving an insignificant distribution
from the estate. In Re Handel is an illustrative case of a debtor's
egregious effort to use bankruptcy planning practices to conceal
a significant portion of assets from creditors.iii In In re Handel,
the bankruptcy court of the Southern District of New York considered
a series of challenges to the Debtor's discharge on the Creditor's
motion for summary judgment.iv Through bankruptcy planning, the
Debtor transferred his partnership payments, investment accounts,
and retirement assets to his wife, a nondebtor. The Debtor asserted
that his actions only constituted transformation of nonexempt
assets into exempt assets and that there was no intent to defraud
creditors. In addition, an issue arose concerning the value of
certain antiques that were listed on an aged financial statement
and the Debtor's bankruptcy schedules. Quite remarkably, the
financial statement at issue was completed approximately ten
years prior to the bankruptcy filing. In its opinion, the bankruptcy
court considered the effect of the Debtor's bankruptcy planning
on the Debtor's prospect for discharge.
Shuffling Exemptions for a Better Hand (el)
Prior to filing the bankruptcy petition, the Debtor transferred
his partnership payments, investment accounts, and retirement
accounts to his wife. The Debtor denied that these transfers
constituted fraud on creditors; rather, the Debtor asserted that
the transfers were a means of protecting exempt assets. The Creditor
disagreed. Pursuant to § 727 (a)(2)(A), the Creditor moved
the bankruptcy court for summary adjudication for a determination
that the debt was nondischargeable.v This required the Creditor
to show that: (1) the transfer occurred one year prior to the
bankruptcy petition; (2) the transfer was done with actual intent
to hinder, delay, or defraud a creditor or an officer of the
estate; (3) the debtor or an agent of the debtor effectuated
the transfer; and (4) the transfer concerned the debtor's property.vi
The only element at issue was whether the transfer occurred with an actual
intent to hinder, delay or defraud a creditor. Since it is unlikely that a
debtor will testify to perpetrating a fraud with "actual intent," courts conduct
an analysis of the "badges of fraud" to determine whether intent exist.vii
The badges of fraud include: (1) inadequacy of consideration; (2) transfer
of property to family and friends; (3) retention of benefits derived from property;
(4) financial condition of the transferring party; (5) transfer of property
after incurring debt, financial difficulties, and suits by creditors; (6) omission
and misrepresentations on the Debtor's schedules; (7) a debtor's reckless indifference
to the truth; and (8) other facts and circumstances evidencing fraud.viii The
bankruptcy court may deny discharge if any one of the badges exist. Although
the Debtor wore several badges of fraud, the bankruptcy court cautiously concluded
that a question of fact remained as to whether these particular transfers were
done with the "requisite intent to hinder, delay, or defraud the creditor.ix
Discrepancy Appears in Handeling of the Antiques' Value
The Creditor also moved for summary adjudication to deny discharge
on the basis that the Debtor made a false oath on financial statements
dating approximately ten years prior to the bankruptcy filing.
Pursuant to § 727(a)(4)(A), discharge may be denied if a
debtor "knowingly and fraudulently ... made a false oath."x Under
this section, an omission alone from a debtor's statement of
affairs or schedules is grounds for denying discharge. At issue
were the values assigned to the Debtor's antiques on an aged
financial statement and his bankruptcy schedules. The financial
statement attested that the value of the antiques was $200,000
whereas the bankruptcy schedules listed the value only at $5,000.
To justify the discrepancy, the Debtor claimed that the financial
statement was a combination of antiques owned by him and his
wife, a majority of which were allegedly purchased by his wife
through monetary gifts that constituted separate property. The
bankruptcy court concluded that a question of fact remained as
to whether the Debtor acted with fraudulent intent. The bankruptcy
court also stated that if the Debtor "sincerely" believed that
the financial statement requested information about assets belonging
to himself and his wife, then the Debtor did not have the requisite
The Bankruptcy Court Handels It to the Benefit of the Creditor
In its final request for summary adjudication to deny discharge,
the Creditor asserted that the Debtor failed to adequately explain
the differences in the values assigned to the antique furniture.xi
Pursuant to § 727(a)(5), discharge may be denied if a debtor
fails to explain "satisfactorily ... any loss of assets or deficiency
of assets to meet the debtor's liabilities."xii Unlike the other
sections, § 727(a)(5) does not require an intent analysis
and is construed broadly. If a creditor establishes that a loss
occurred, the burden shifts to the debtor to explain that any
conduct was the product of good faith and business-like conduct.
Furthermore, vague and indefinite explanations of losses are
deemed unsatisfactory if based on estimates and uncorroborated
by documentation. The bankruptcy court concluded that the Debtor's "self-serving" statements
regarding ownership and value of the antiques were unavailing
and not corroborated with any documentation. Accordingly, the
bankruptcy court entered summary judgment for the Creditor and
denied the Debtor's discharge.
In re Handel is an illustrative case of the effect of bankruptcy
planning on a debtor's discharge. It also presents a valid avenue
for creditors to challenge discharge if the creditor can research
the debtor's prior financial dealings. Although the courts may
consider certain practices as legitimate (e.g., transformation
of nonexempt assets to exempt assets), other practices are clearly
suspect and may be grounds to deny discharge (e.g., value discrepancies
and transfers to insiders). The bankruptcy court is clear that
the intent requirement under certain provisions of § 727
is the central focus of the inquiry. If intent can be inferred
from the facts and circumstances of a particular case, then a
creditor may be able to successfully challenge a debtor's discharge.
The creditor need not establish actual intent. Moreover, § 727(a)
(5) does not require any showing of intent if there is a discrepancy
in the value of assets listed on financial documents, or any
other document, and the debtor's bankruptcy schedules. If a discrepancy
is found, a debtor is required to satisfactorily explain the
disappearance of assets prior to the bankruptcy filing. If the
debtor fails to satisfactorily explain the demise in assets,
then discharge may be denied and the creditor may seek recovery
from the debtor for the full amount of its claim.
i. The Bankruptcy Code gives each state an option with regard to exempt property
that is protected from creditors. Pursuant to the Bankruptcy Code §§ 522
and 541, a state may allow debtors to: (1) exempt from their bankruptcy estates
property included in the federal "laundry list" of exemptions, or (2) rely
on state law and federal law other than the laundry list for allowable exemptions.
See 11 U.S.C. §§ 522 and 541. Additionally, a state may also entirely "opt
out" of the federal exemption scheme. See 11 U.S. C. § 522(b)(1).
The option scheme has provided for varied results among the states. For example,
pursuant to federal law, the exemption value for a homestead is $15,750.00.
However, the State of Florida, subject to very limited exceptions, provides
an exemption for the full value of the homestead. See Fla. Const. art. X § 4
(West 2002); See also Fla. Stat. § 222.01 (West 2002). Additionally, states
may add exemptions for personal property that are not listed under the Bankruptcy
Code. A unique exemption is found under Texas law, which permits an exemption
for two (2) firearms (certainly, this adds to smooth relations among aggressive
creditors). See Tex. Prop. Code. Ann. § 42.002(a)(7)(West 2002). As one
Texas bankruptcy court noted, "the typical hunter serious about his or her
sport will have a shotgun for birds and a rifle for other game." See In re
Schwarzbach, 1989 WL 360742, *4 (W.D. Tex.1989).
ii. A majority of consumer debtors willpossess assets that meet the exemption
requirement under state and federal law, and therefore, these assets are out
of the reach of creditors.
iii. See In re Handel, 266 B.R. 585 (Bankr. S.D.N.Y.2001).
iv. The Debtor also filed a cross-motion for summary adjudication, which the
bankruptcy court denied on all claims. The bankruptcy court did not discuss
the reasoning for its denial of the cross-motion for summary judgment.
v. See 11 U.S.C. § 727(a)(2)(A).
vi. See Id.
vii. See Najar v. Kablauoui (In re Kablaouli), 196 B.R. 705, 709 (Bankr.S.D.N.
viii. See Salomon v. Kaiser (In re Kaiser), 722 F.2d 1574, 1582-83 (2nd Cir.
ix. The Creditor also moved for summary adjudication pursuant to § 727(a)(2)(B)
for transferring unnamed assets from his estate to his wife's account. Section
727(a)(2)(B) permits the bankruptcy court to deny discharge if the debtor,
with an intent to "hinder, delay, or defraud a creditor.. .transfers property
from the estate, after the date of filing the petition." See 11 U.S.C. § 727(a)(2)(B).
The bankruptcy court concluded that the same analysis under § 727 (a)(2)(A)
applied and denied summary judgment to determine whether the transfers were
to protect exempt assets or to defraud creditors. See In re Handel, 266 B.R.
x. See 11 U.S.C. § 727(a)(4).
xi. The Creditor also moved for summary adjudication on the basis that the
Debtor failed to adequately explain the reasons that his capital account at
his law firm had a positive value of $400,000 in 1989, whereas it had a negative
value at the time the bankruptcy petition was filed. See In re Handel, 266
B.R. at 590. The Debtor attributed the negative balance to a change in accounting
methods and the loss of a valuable asset at the firm. See Id at 591. Although
the bankruptcy court denied summary judgment on this issue, it did not state
its reasoning. The logical inference is that the bankruptcy court believed
that this explanation was satisfactory. xii. See 11 U.S.C. § 727(a)(5).
Blakeley & Blakeley LLP Reprinted
by permission from Trade Vendor Quarterly