Prebankruptcy Planning: Conversion of Nonexempt Assets Into Exempt Assets

• Publication year: 1992
• Pages: 231
• Citation: Vol. 21 No. 2 Pg. 231

21 Colo.Law. 231 Colorado Lawyer 1992.

1992, February, Pg. 231. Prebankruptcy Planning: Conversion of Nonexempt Assets into Exempt Assets

---

231

Vol. 21, No. 2, Pg. 231

Prebankruptcy Planning: Conversion of Nonexempt Assets into Exempt Assets

by Paul G. Hyman, Jr

Heretofore, little thought has been given to whether Colorado residents should engage in prebankruptcy planning, because of the meager exemptions allowed under Colorado's laws. However, the Colorado General Assembly recently amended the state's exemption laws to allow for full exemption for all pension plans, retirement plans and deferred compensation plans in which the debtor has received benefits or payments or has the right to receive future benefits or payments.(fn1) The exemption is likely to encourage individuals fearing bankruptcy is imminent to invest large sums of money in these plans. This type of "prebankruptcy planning" may enable a debtor to keep assets that otherwise would fall into the hands of his or her creditors.(fn2)

However, such planning can be risky. Although prebankruptcy planning is not prohibited by federal or state exemption laws,(fn3) if a debtor converts nonexempt assets into exempt assets with the "intent to hinder, delay or defraud" creditors, discharge of the debtor's debts may be denied.(fn4) This article examines the state of the law today to determine how a debtor effectively can use exemptions to preserve his or her assets.

Purpose of the Bankruptcy Code

Bankruptcy law attempts to provide the debtor with a "fresh start" in his or her financial affairs.(fn5) The fresh start policy is effectuated by allowing the debtor to treat certain types of property as exempt from execution by creditors and by discharging any debts with certain limited exceptions that remain after the debtor's nonexempt assets are distributed.

Congress included exemptions in the Bankruptcy Code ("Code") so the debtor would be able to return to a normal life and not be destitute or a public charge.(fn6) However, recognizing that economic conditions vary throughout the country, the Code authorizes states to "opt out" of the federal exemptions and devise their own exemption schemes.(fn7) Colorado has chosen to opt out of the federal scheme and deny its residents the right to choose the exemptions found in 11 U.S.C. § 522 (d).(fn8) In accordance with the federal policy, the Colorado exemption scheme allows a debtor to retain

the tools of his trade or profession, some minimal food and clothing, the means to provide shelter for he [sic] and his family and some household goods.(fn9)

Although the purpose of the exemptions is to enable a debtor to live a normal life, the ultimate goal of bankruptcy is the discharge of debts. Discharge is favored by bankruptcy law.(fn10) A debtor is entitled to a discharge unless the court finds a violation of 11 U.S.C. § 727.(fn11) The Code is construed strictly against those who intentionally violate its provisions.(fn12) Thus, as mentioned above, even if a debtor transfers nonexempt property into exempt property as authorized by Colorado law, discharge will be denied if the transfer was intended to hinder, delay or defraud creditors.(fn13)

Denial of Discharge Under 11 U.S.C. § 737(a)(2)

A debtor's entitlement to discharge is a federal question and is governed by 11 U.S.C. § 727.(fn14) For a denial of discharge to be sustained under § 727(a)(2), a creditor is required to prove four elements:

1) that the act complained of was committed within one year prior to the filing of the bankruptcy petition;

2) that the act was carried out by the debtor or one of the debtor's duly authorized agents;

3) that the act consisted of...