When you file for Chapter 7 bankruptcy, everything you own becomes part of the bankruptcy estate. Some of this property is exempt under state or federal law, which means you get to keep it in bankruptcy. The rest -- your nonexempt property -- can be taken by the trustee to be distributed to your creditors.
In some cases, property you've already given or sold to someone else (or money you've paid to someone, including a creditor) can be taken back into your bankruptcy estate. These pre-bankruptcy transactions are called "preferential" transfers or fraudulent transfers, and they can be voided by the trustee.
What is a Voidable Transfer?
A voidable transfer is any transfer of assets (property or money ) you made prior to filing for bankruptcy that the trustee decides should be reversed so that all of your creditors are treated fairly in the distribution of your liquidated assets.
Two types of voidable transfers are preferential transfers and fraudulent transfers.
A preferential transfer (or preference) is a payment to a creditor before you file for bankruptcy. For example, if your mother lent you $1,000, you may want to pay her back before you file. That way, your $1,000 would go to her instead of your credit card company and other creditors. She would be repaid in full, rather than having to get in line with all the rest of your creditors, receive pennies on the dollar (if that) for the money you owe her, and then see the debt wiped out when your bankruptcy case is over.
Preferences are voidable transfers, because they pay off one creditor at the expense of the rest. A preference you pay to an insider -- a family member, friend, or business associate -- can be voided if it took place in the year before you filed and involved more than $600. An arms-length transaction can be voided if it took place in the three months before you filed and involved more than $5,475.
A fraudulent transfer takes place when you transfer property out of your bankruptcy estate before filing by, for example, selling it for significantly less than it's worth or giving it away. For example, if you give your new car to a sibling before filing, in order to shield it from your creditors, that would constitute a fraudulent transfer.
If you make a fraudulent transfer, the trustee can have it voided and pull the property or money back into your bankruptcy estate. But there's more: If the trustee believes that your intention was to hide the property, your bankruptcy case may be dismissed. In some situations, you may have simply made a generous gift, not realizing that you would later have to file for bankruptcy. But if you gave away property in contemplation of filing for bankruptcy, you could end up in big trouble.
What Raises The Red Flag?
The trustee who is supervising your bankruptcy will examine your paperwork in detail. In the Statement of Financial Affairs, you must list all financial transactions that might be voidable, such as payments to creditors, gifts, and transfers of property. If any of your answers to these questions seem suspect, the trustee might investigate further. The trustee may also search state and local databases for financial information about you, which could turn up title documents. And, the trustee and your creditors are entitled to ask you questions under oath, at the meeting of creditors, regarding pre-filing transfers.
If you are thinking about bankruptcy and are worried that you might have inadvertently created a voidable transfer scenario, talk to a bankruptcy attorney. An attorney can answer your questions, help you with lawful pre-bankruptcy planning, and manage any issues that come up along the way.