When an individual files for bankruptcy, a trustee is assigned to his/her case. It is the trustee’s duty to administer the case. Part of the administration of a bankruptcy case involves an examination of financial transactions occurring before an individual files for bankruptcy. One thing trustees look at is whether a debtor has transferred any property out of his/her name before filing. The trustee is able to look into transactions between a debtor and a family member or close friend that have occurred within six years of filing a bankruptcy.
Many transfers of property which are commonplace outside of a bankruptcy context can be characterized as fraudulent if a debtor files for bankruptcy. If a transfer is considered fraudulent, the trustee is allowed to go back to the individual who received the transferred asset and demand the asset or the fair market value of the asset. If that individual does not return the asset or the value of the asset willingly, the trustee then may sue that individual and get a judgment against that person for the value of the asset or force the person to return the asset. Understandably, many debtors are greatly distressed by this.
Whether a transfer is considered fraudulent is determined by the bankruptcy code and surrounding case law. Section 548 of the Bankruptcy Code defines fraudulent transfers as transfers made with  “actual intent to hinder, delay, or defraud” a creditor or  a transfer in which the debtor “received less than a reasonably equivalent value in exchange for such transfer…and was insolvent on the date that such transfer…or became insolvent as a result of such transfer…”
Actual Fraud occurs when the debtor transfers property with the intent to hinder, delay, or defraud a creditor. A debtor may not always disclose the true reasons behind the transfer, and to prove intent the court may look to the circumstances surrounding the transfer. The badges of fraud that indicate fraud include: the timing of the transfer, the relationship between the debtor and the recipient, the lack of adequate compensation the debtor got for the transfer, and whether or not the debtor maintained control over the asset after transferring title.
A common example of actual fraud is: A debtor is behind on his credit card payments and realizes that he is on the verge of being sued by his creditors. He has hunting land up north that is free and clear and worth $30,000. He is worried that creditors will sue him and take the land. He transfers title to the property to his brother without having the brother pay him the $30,000 that the land is worth.
This is actual fraud because the debtor intended to hide property from his creditors. The trustee has a few options. He or she can (1) not discharge the debtor’s debts, (2) make the brother pay $30,000 or (3) force the sale of the property. The trustee will distribute the $30,000 among the creditors to pay a portion of the debt owed to them by the debtors.
Another form of fraud is called “constructive fraud.” It is constructive rather than actual because there need not be any intent on the part of the debtor. Constructive fraud occurs when a debtor (1) sells or gives away an asset for less than fair market value (2) at a time when he or she is insolvent. Fair market value is determined on a case by case basis. In essence, when the court takes into consideration all factors surrounding the transfer, it is determining if the debtor did not receive proper consideration for the transfer, i.e. whether or not the debtor gave someone a deal or a gift.
Insolvency is shown by determining that the debtor’s liabilities are greater than his or her assets. A simple way to conceptualize this is by answering the question: was the debtor able to pay his debts at the time of the transfer? If the answer is no, the debtor is insolvent.
A common example of constructive fraud is: A debtor who has not been able to stay current on his credit card bills, has an adult daughter whose car has just broken down. The debtor gives his daughter his older car worth $3000 to take and use as her own. The debtor transfers the title to his daughter’s name without having the daughter pay for the car.
This is constructive fraud because the debtor did not give the car to his daughter intending to hide it from creditors. Instead, his motives were innocent: he only wanted to help his daughter who was without a car. However, the trustee can make the daughter (1) pay $3000 to keep the car or (2) force the sale of the car, using the profits to divvy up among the creditors.
Debtors who file for bankruptcy generally do not want to involve their family or friends in the process and see it as unfair that the trustee can take back property given to them. However, creditors also have rights and sometimes have a right to repayment in a bankruptcy case.
This aspect of the bankruptcy code is designed to keep individuals who are filing bankruptcy from cheating their creditors by hiding assets. Although this is often not the debtor’s true intention when the transfer occurred, the person filing the bankruptcy may still encounter problems under this section of the bankruptcy code.
It is important for an individual who may consider a bankruptcy to speak to an experienced attorney before any such transfers are made.