Giving a gift to a friend or family member prior to filing for Chapter 7 bankruptcy may be a perfectly harmless, routine action to take. It can also be a mistake that endangers your case and causes a lot of trouble for the recipient of the gift.
Why is it a problem to give a gift prior to filing for bankruptcy?
The answer may be a little more apparent if we re-phrase the question slightly, to-wit: “Is it okay if I transfer cash or valuable property for no value received before filing for bankruptcy?”
Do you see the issue?
If not, we will discuss below. However, you likely at least noticed in that rephrasing the notable lack of sentiment or even holiday spirit.
Once you strip the glowing sentiment out, a gift is, essentially, simply a property transfer. It doesn’t matter, in Chapter 7 bankruptcy, why you transferred it (birthday, anniversary, Christmas or holiday gift), only that you did.
And that it wasn’t a sale of property for fair-market value.
Depending on how much you spent on the gift or what the value of the cash transferred happened to be, this can be a property transfer that entitles the Chapter 7 Trustee assigned to your bankruptcy estate to later claw that property back in order to repay some of what you owe to your creditors.
Let’s dig in.
Your Property and the Chapter 7 Bankruptcy Estate
When you file for Chapter 7 bankruptcy, your property temporarily ceases to be your property. Instead, it becomes an asset of what is known as “the Bankruptcy Estate.”
The Bankruptcy Estate is a fictional structure that contains everything you own and any property you are entitled to (i.e., wages earned but not yet paid, a claim for personal injury damages, etc.) as of the date that you file your case.
It can also contain property that you used to own but no longer do. Because you gave it away.
Or gifted it.
The purpose of the Bankruptcy Estate is to allow a person called the Chapter 7 Trustee to examine your assets then determine the value of your assets and to liquidate those assets if above a certain value.
The Chapter 7 Trustee is, in fact, the Trustee of the Bankruptcy Estate. As soon as you file your case, the Chapter 7 Trustee is empowered to liquidate any property in the Estate which cannot be fully exempted (more on that below!).
You create the Bankruptcy Estate by automatic function of law when you file a Chapter 7 case, and the Trustee is assigned to your case by function of that same law.
The purpose of all of this is to ensure that creditors are at least partially compensated for their loss that your bankruptcy will cause them, where it is merited.
A Chapter 7 bankruptcy is a “liquidation” bankruptcy. Unlike Chapter 13, it does not require that you repay anything back on the debts that you owe.
Instead, Chapter 7 requires that, if you own too much stuff or one or more luxury items of sufficient value, you give up that property in exchange for the enormous governmental benefit of being relieved of all (or nearly all) of your debt.
That all said, most people who file Chapter 7 bankruptcy lose nothing.
Those “exemptions” mentioned above are the dollar-value caps for the different types of property you are allowed to retain.
There are a variety of exemptions for different types of property (automobile, jewelry, and so on). They have differing dollar-value caps (or exemption amounts) depending on what sort of property it is.
Some types of property (such as a vacation property or baseball card collection) have no exemption protecting them at all.
What else cannot be exempted?
Property that you transferred or gifted prior to the filing of your case. If you don’t have it, you can’t exempt it.
That doesn’t mean it can’t be brought back into the Bankruptcy Estate by the Chapter 7 Trustee.
The Chapter 7 Bankruptcy Trustee and Avoidable Transfers
Liquidating property on hand at the time that you file for Chapter 7 is not the only power enjoyed by your Chapter 7 Trustee.
The Trustee can also “avoid” (or unwind, or undo) transfers of cash or property made under certain circumstances within the 2 years (or even up to 6, under Michigan law) prior to the filing of your bankruptcy case.
A gift is a property transfer that will always have been made under those “certain circumstances.”
What are those circumstances?
Under Federal law, the Chapter 7 Trustee can avoid any transfer of cash or property made for less than reasonably equivalent value outside of the normal course of business within the 2 years prior to the filing of the bankruptcy case.
The Chapter 7 Trustee can also potentially avoid such transfers made up 6 years prior to the filing of the case under Michigan’s own fraudulent transfer statute.
What does any of that mean?
- “Less Than Reasonably Equivalent Value”
This simply means that you gave something away for either nothing or less than what it is worth. If you quitclaim an entire house to your brother-in-law for $1.00, that is very likely less than the house is actually worth, or less than the house’s “equivalent value.”
The use of the word “reasonably” is a recognition by the US Congress, which drafted the US Bankruptcy Code from which this fraudulent transfer definition arises, that an honest disagreement about what is or isn’t the reasonably equivalent value of transferred property may arise.
In that situation, at a so-called evidentiary hearing (or trial on the subject of what the property is worth), your expert witness (an appraiser, etc.) will testify as to his or her opinion of the property’s value and the basis used by the expert to arrive at that number.
The Chapter 7 Trustee’s own expert witness will do the same—and then the Bankruptcy Judge will decide which expert is the most credible, or accurate.
A gift, however, is unlikely to be the subject of such a hearing. A gift is, by definition, given to someone for nothing in return. Therefore, it will automatically have been a transfer for “less than reasonably equivalent value.”
Depending on the value of the gift, a Chapter 7 Trustee will be more or less interested in clawing it back into the Bankruptcy Estate. A $5.00 McDonald’s gift card? Probably not an issue (though it must still be disclosed!). A $500 necklace? Now we’re entering dangerous territory.
- “Outside of the Normal Course of Business”
This means that a transfer isn’t fraudulent if it was conducted as part of your normal business operation. For example, if you make your living buying junk cars, fixing them up, and then selling them, the sale of those fixed-up cars is not fraudulent.
Especially if you sell them for market rates. If you give one to your cousin for $1.00, again, all bets are off.
- “Within the 2 Years Prior to Filing”
This means what it says. Any transfer made under the above circumstances within 2 years of the date that you file your Chapter 7 bankruptcy case is subject to scrutiny.
One thing not required under the US Bankruptcy Code for a finding that a transfer was fraudulent is intent.
That is, it doesn’t matter that you didn’t mean to commit fraud. If you transferred property under the above circumstances, fraud as defined by Federal Bankruptcy law is the result.
It doesn’t matter that the gift was a Christmas present. Or a wedding present. Or a Bar Mitzvah gift. Or to help with college expenses.
Regarding Michigan law, mentioned above, the look-back period is 6 years, not years, but it does require that you have intended to hinder, defraud, or delay your creditors’ collection attempts at a time when you were legally insolvent for a fraudulent transfer to be determined.
That complicates the burden of proof for a Chapter 7 Trustee at trial, but the “legally insolvent” bar is a low one, for most people. Did you owe more in debt at that time than your assets were worth?
If so, you were legally insolvent, and your gift could be scrutinized under this test as well.
Gifts Prior to Chapter 7 Bankruptcy: The Bottom Line
The bottom line is that you need to disclose all such gifts and transfers to your bankruptcy lawyer up front at your initial consultation, especially if the value involved was $600 or more.
Chapter 7 Trustees are very good at reviewing bank statements, tax returns, deeds, vehicle titles, and other such records for evidence of avoidable fraudulent transfers. The Bankruptcy Petition itself requires that such transfers be affirmatively disclosed.
It is crucial that you give your Detroit bankruptcy lawyer the information needed to provide you the best advice possible.
Under very specific circumstances, a gift can be “un-done” prior to filing. Otherwise, your attorney may want to advise you to wait to file your Chapter 7, or to file a Chapter 13 bankruptcy instead (in which transfers are rarely avoided unless egregious fraud is apparent)—or to not file bankruptcy at all.
Attorney Walter Metzen has assisted thousands of Metro Detroit clients through Chapter 7 bankruptcy for over 28 years. A Board Certified bankruptcy expert, Attorney Metzen offers free consultations and friendly customer service.
Contact us now to schedule your initial consultation.