Perils of Pre-bankruptcy Planning: Transfers, Exemptions and Taxes
| Publication year | 1988 |
| Pages | 1513 |
| Citation | Vol. 08 No. 1988 Pg. 1513 |
1988, August, Pg. 1513. Perils of Pre-Bankruptcy Planning: Transfers, Exemptions and Taxes
Most clients contemplating bankruptcy want to shield assets from their creditors, to the extent possible. As a result, attorneys representing such clients will likely be asked for advice on whether and how assets can be protected, such as by purchasing exempt property,(fn1) by converting nonexempt property to exempt property or by transferring assets to a non-debtor. This request for advice often occurs on the eve of bankruptcy.
Some techniques of pre-bankruptcy planning work better than others. However, with every attempt there are risks, arising from both the Bankruptcy Code and from state law. This article addresses these risks, discusses ways of reducing the risks of transfer, and offers a short summary of some of the tax considerations of pre-bankruptcy planning.
The United States Criminal Code provides for punishment for anyone who "knowingly and fraudulently transfers or conceals any of his property or the property of such other person or corporation. . . ." This criminal offense carries the penalty of a fine of not more than $5,000, imprisonment of not more than five years, or both.(fn2)
The Criminal Code may be violated by persons other than the debtor. For example, an attorney-accountant, who helped incorporate a travel agency that had become a debtor, was sentenced to five years in custody and ordered to pay restitution of $72,984.33 for, among other things, his pre-petition transfer (and, ultimately, personal use) of a check for $14,000 and $43,000 in proceeds from tickets sold by the travel agency.(fn3)
Perhaps more important to attorneys personally is the case of United States v. Parkhill, which "sadly illustrates the peril of practicing law in an unfamiliar subject area, for, as one attorney has learned, ignorance of the law does not excuse an offense."(fn4) In Parkhill, a bankrupt businessman and the attorney who represented him during his bankruptcy proceeding were convicted of fraudulent concealment and transfer of assets in violation of 18 U.S.C. §§ 2 (aiding and abetting) and 152. Prior to being adjudicated an involuntary debtor, the attorney had transferred his ownership in three tracts of land to a trust set up for his wife and son. Upon the advice of his attorney, who had never handled a bankruptcy case, the businessman failed to mention this transfer on his bankruptcy schedules. After being adjudicated an involuntary debtor the businessman, again with the assistance of his attorney, transferred the tracts of land and four motor vehicles to a third party for $150,000.
A jury found both men guilty of violations, and the court fined them both $5,000 and placed them on probation for five years. The U.S. Court of Appeals for the Fifth Circuit affirmed the conviction of both defendants.(fn5)
Although clients contemplating bankruptcy may have little concern for civil liability, attorneys are differently situated. Attorneys have been found liable to creditors for participating in a scheme to delay the creditors' access to assets of the debtor/client.(fn6) Although for liability to occur it is not necessary for the attorney to have been the beneficiary of the transfer, the attorney's conduct must have been intentional and not merely negligent with respect to the rights of the non-client creditor. There appears to be no Colorado cases dealing with claims of a non-client creditor; however, Colorado does recognize attorneys' liability to non-client third parties for fraudulent or malicious conduct.(fn7)
The statute of limitations for such a claim would presumably be the three-year statute for fraud, misrepresentation, concealment or deceit. However, the cause of action would not accrue until discovery, or when discovery would have occurred by the exercise of reasonable diligence.(fn8)
Denial of discharge is the capital punishment of the Bankruptcy Court. It means that the single greatest benefit of a bankruptcy---discharge of indebtedness---is lost, and the creditor whose debt is found non-dischargeable may follow
the debtor to the grave seeking recovery on this debt. Creditors are also likely to pursue this remedy, particularly when they feel wronged by a borrower.
The most serious discharge denial is when the debtor is denied any discharge through the bankruptcy.(fn9) A discharge can be denied for transfers of property within one year of the date of the petition if the transfer is made "with intent to hinder, delay or defraud a creditor" or trustee.(fn10) The intent can be established by the circumstances, such as a transfer to an entity controlled by the debtor's family for no consideration.(fn11)
Debtors have great difficulty predicting when it will be necessary to file a voluntary bankruptcy petition. Predicting the future undesirable effect of a transfer is made even more difficult by the tendency of unpaid creditors to want to file an involuntary bankruptcy petition when they have discovered that the debtor is transferring property.(fn12)
A discharge may also be denied for knowingly and fraudulently making a false oath or account, for unjustified destruction of books and records, or for misconduct in connection with the case. The burden in seeking to have a discharge denied is on the objecting creditor or trustee. The objector's burden is onerous because the courts are virtually uniform in holding that the discharge provision is to be construed liberally in favor of discharge and strictly against the objector seeking to block the discharge.(fn13)
In addition, specific debts may be found non-dischargeable, typically for written misrepresentation of financial condition or for fraud or willful and malicious injury to the property of another.(fn14) Again, the burden of proof is difficult for creditors bringing such actions; the creditor must prove all elements of non-dischargeability by clear and convincing evidence.(fn15)
The Bankruptcy Court narrowly construes exceptions to discharge in favor of the debtor.(fn16) For instance, the creditor must plead fraud with particularity, perhaps to the extent of referring specifically to the false written financial statement, if that is the basis for the non-dischargeability claim.(fn17) The creditor must prove that it relied on false statements, in a discharge objection based on written financial statements, and must prove that the reliance was reasonable.(fn18)
A debate currently rages in the courts and among commentators over whether pre-bankruptcy conversion of assets to make maximum use of exemptions can be the basis of denial of a discharge.(fn19) Despite legislative history that clearly seems to authorize such transfers,(fn20) and despite a strong public policy...
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