Red Flags in Bankruptcy
How to Avoid Problems When Filing for Bankruptcy
If you are considering filing for bankruptcy, there are many factors that must be considered. It is therefore of utmost importance for your bankruptcy attorney to have a thorough knowledge of your financial and legal situation. When meeting with a new client, I take the time to talk with the client and review all necessary information. The initial meeting with a client usually takes between one and two hours. I ask a lot of questions, not only to gather the information needed to prepare the bankruptcy petition, but also to determine if there are any potential problems. Often, these issues can be addressed by proper planning. If necessary, we will wait to file the bankruptcy petition to allow certain time periods to pass. Below are some of the “red flags” that can lead to trouble if not addressed prior to the bankruptcy filing.
Problem: Asset Transfers
Transfers of assets for less than fair value, when the debtor was either insolvent at the time of the transfer, or was made insolvent by the transfer, are considered fraudulent and can be recovered by a Chapter 7 trustee. This usually arises in the context of a transfer from the debtor to a spouse or other family member. If the debtor did not receive fair value in return, then the reason for the transfer is not relevant. In addition, transfers made with intent to defraud creditors are considered to be fraudulent conveyances, regardless of the insolvency of the debtor. Keep in mind that the Statement of Financial Affairs, which must be filed with the bankruptcy petition, only requires disclosure of transfers made within the two years preceding the bankruptcy filing. However, at the meeting with the bankruptcy trustee, the debtor will always be asked about transfers made within the prior six years. This is because the statute of limitations for fraudulent conveyances in New York is six years, and a Chapter 7 trustee in New York can recover fraudulent transfers made within that time period.
- Wait to file. The simplest answer, if possible, is to wait until the six years has passed before filing the bankruptcy. This is a realistic solution only if the six years will be expiring sometime in the near future.
- Undo the fraudulent transfer. Fraudulent transfers in New York can be “undone” by transferring the asset back to the debtor. Whether this makes sense, depends on the value of the asset and whether or not it can be exempted in a Chapter 7 bankruptcy. However, it is important to consult with a bankruptcy attorney before transferring assets back to the debtor. Under certain circumstances, it may be necessary to wait one year after re-conveying the property to file the bankruptcy petition.
- File under Chapter 13. When filing a Chapter 13 bankruptcy, fraudulent transfers are considered in a “liquidation analysis” of the Chapter 13 plan. That is, the amount to be paid to unsecured creditors must be at least what they would receive in a Chapter 7. So, to the extent that a fraudulent transfer could be recovered by a Chapter 7 trustee, the value of that property must be considered in determining whether the Chapter 13 plan proposes to repay creditors a sufficient amount.
- File the bankruptcy anyway. A fraudulent transfer made within one year of the filing, with the intent to defraud a creditor, or the bankruptcy estate, can result in a denial of discharge. However, aside from that, fraudulent transfers usually will not affect a debtor’s discharge. The consequences of a fraudulent transfer will fall upon the recipient of the property. If this is a spouse, then filing the bankruptcy can be a problem. However, if the property was transferred to, for instance, a former girlfriend/boyfriend, then filing the bankruptcy may not have any negative consequences for the debtor.
Problem: Preferential Payments to Insiders
Debtors who have borrowed money from family members or friends often wish to repay these loans before filing for bankruptcy. If repayment was made within the one year preceding the bankruptcy filing, a Chapter 7 trustee can recover the money that was paid, and redistribute it among all of the debtor’s creditors.
- Wait at least one year from the date of the repayment before filing for bankruptcy. This eliminates the problem entirely.
- Have the friend or family member return the payment. This is considered a new loan and will serve to undo the preferential payment.
Problem: Home Equity Loans or Cash Received From Refinancing the Debtor’s Home
It is common for people to have taken equity out of their homes in recent years. This can be a potential problem, depending on how much time has elapsed between the receipt of the funds and the bankruptcy filing, as well as the amount of cash taken out.
The debtor must be able to account for how the money was used. This information does not appear anywhere in the schedules that are filed with the bankruptcy petition. However, the bankruptcy trustee will always inquire as to how the proceeds of a refinancing or home equity loan were used. I always advise my clients to make up a list of how the money was spent. If it was for home improvements, they should be able to tell the trustee the specific work that was done on the house and the cost of the work. If debts were paid, the debtor should be able to say what debts were paid and how much. Often, debts are paid directly from the loan proceeds and will show on the HUD-1 statement that is prepared at the closing. Sometimes, loan proceeds are used for living expenses. If this was the case, there should be a reason for doing so, usually because of extended periods of unemployment. Again, preparation is the key to avoiding problems with the bankruptcy trustee.
Problem: Recent Credit Card Usage
Using credit cards in the period leading up to the bankruptcy filing must be avoided. If there has been substantial recent usage on the credit cards, especially for purchases that are not essential, the debtor can be denied a discharge, or the debts can be deemed non-dischargeable.
Solution: Wait to file.
Under certain circumstances, it may be advisable to wait six months to one year after using the credit cards to file for bankruptcy. This will allow a sufficient amount of time to pass so that the credit card usage is not an issue. If the debtor can make minimum payments on the credit cards, this will show a good faith intention to repay the debt, and will also prevent the commencement of legal action against the debtor while waiting to file for bankruptcy.
Problem: The debtor earns cash income
When filing for bankruptcy, debtors must disclose their current income; the income that they have earned in the six months preceding the bankruptcy filing; and their income for the prior two calendar years. Pay stubs for the 60 days preceding the bankruptcy must be filed with the petition. In addition, debtors must provide the bankruptcy trustee with their most recently filed tax return. Problems can arise if the debtor works “off the books” or is self employed.
If working for an employer, the debtor should start getting paid on the books. This is the only legitimate way for an employee to be paid. However, the debtor must also accurately disclose his or her actual income for the preceding six months, as well as the prior two calendar years.
If the debtor is considered to be an “independent contractor”, then it is important that all income is deposited into a bank account, so that the income can be documented. Expenses should then be paid for by check or debit card. The debtor’s tax return should reflect their actual cash income.
If the debtor is self-employed, there should be a separate bank account for the business. Business expenses should be paid from the business account. All income and expenses should be documented so that the net business income can be determined.
All of the above scenarios could result in discrepancies between the debtor’s actual income and the income reported on the debtor’s tax returns. If necessary, the debtor’s tax returns should be amended. While this may result in additional tax liability (which would not be dischargeable), it is the preferable course of action. Otherwise, the debtor may be asked by a bankruptcy trustee to explain the discrepancies. Or worse, the debtor could be faced with a possible inquiry by the I.R.S. or state tax department.
Andrew M. Doktofsky, P.C. | Long Island Bankruptcy Attorney Explains Potential Problems in Bankruptcy
Contact Andrew M. Doktofsky, P.C. today at 631-812-7020 for a free consultation about how to avoid problems when filing for bankruptcy, throughout Suffolk County, Nassau County, and Long Island. Andrew Doktofsky is an experienced Long Island bankruptcy lawyer who will advise you on how to properly prepare for bankruptcy in order to achieve a favorable outcome.