Certain after-acquired income belongs to bankruptcy estate
The filing date of the bankruptcy petition is line of demarcation. Everything you owned as of that date is no longer yours: it belongs to the bankruptcy estate. And, most property acquired after that date is yours. Thus, wages and other sources of income, including self-employment income, earned and received after the Chapter 7 bankruptcy action begins generally are excluded from the proceeding.
Given this fact, a debtor who works on a contract basis (e.g., a building contractor) could postpone forming any lucrative contracts until after the proceeding commences. Similarly, where only one spouse works, planned employment for the other spouse should begin only after the action is filed. In these situations, it is better to wait until after the action is completed (not just filed), if at all possible, to avoid any allegation of fraud.
After-acquired assets can become part of the bankruptcy estate. Although nearly all assets earned and received after the proceeding begins are excluded from the bankruptcy, there are a few exceptions. These are:
- property received through inheritance
- property received as a result of a pre-bankruptcy divorce or legal separation settlement
- life insurance or other death benefits
- tax refunds related to pre-bankruptcy filing tax years
These assets are brought back into the bankruptcy action if they are received during the proceeding or within six months of the final discharge.
Thus, if an inheritance were anticipated, the debtor should obtain a legal opinion establishing the inheritance, and then consider filing the action immediately so that the inheritance would be received after the six-month period. Similar timing issues revolve around divorce. There is generally little you can do about the timing of life insurance payments or death benefits.
Trustee can avoid preferential transfers
Once the petition is filed and the bankruptcy estate is created, the bankruptcy trustee will begin to "marshall" the estate's assets. The trustee has the power to undo ("avoid") a transfer of money or property that occurred before the bankruptcy was filed if these transfers are considered "preferential" transfers. These "preferential transfers" will be brought back into a Chapter 7 bankruptcy action and included in the assets available for liquidation.
Although the trustee's powers are far-reaching, they are not unlimited. In order to "avoid" the transfer, all the following conditions must be met.
- There must have been a transfer.
- The transfer must have been for the benefit of the creditor.
- The transfer must have been made to satisfy a pre-existing debt.
- The debtor must have been insolvent at the time of the transfer.
- The transfer must have taken place within 90 days prior to the bankruptcy filing (or within one year if the creditor is an "insider" under bankruptcy law.)
- The creditor received more as a result of the transfer than would have been received under the bankruptcy distribution of assets.
As a business owner, it is possible that you could be on the receiving end of the transfer, rather than in the role of the bankruptcy debtor. If you receive payment for goods and services from a company that files for bankruptcy the next week, then you may have the U.S. Trustee knocking on your door to recover the payment you received. "Intent to defraud" is not necessary for a transfer to be "preferential." It doesn't matter if you acted in good faith or not.
If you find yourself in this position, there are actions you can take to prevent the trustee from nullifying the transfer and requiring you to stand in line with all the other creditors.
Look to see if all the requirements for a preferential transfer are met. If they are (which is likely,) then, you may be able to assert one or more of the following defenses: "course of business," "new value," "contemporaneous exchange," and "purchase money security interest."
The rules for claiming these defenses can be complex, so it is advisable to consult an attorney who is experienced in business law--ideally in creditor's rights law.
When possible, then, transfers to insiders should be planned and carried out more than a year before the action is filed. In theory, however, bankruptcy courts can go back in time (in some cases as much as four years) and undo transfers proved to be fraudulent.
However tempting it may seem to transfer your assets to avoid having them distributed in bankruptcy, it can be a very costly strategy.
If the transfer is found to be "fraudulent," then you may expose yourself to a number of painful consequences, ranging from denial of a bankruptcy discharge to jail time in extreme cases.
Of course, not all transfers are fraudulent, but if you are contemplating asset transfers and are tettering on the edge of insolvency, work with an attorney to ensure the best course of action.
Discharging personal liability in Chapter 7
In a Chapter 7 filing, the debtor's personal liability for dischargeable debts is erased. However, liens that are not subject to elimination (i.e., most consensual and statutory liens) survive the discharge. This is why a homeowner must continue to pay the mortgages on his home, or face foreclosure, even after a Chapter 7 action is completed.
The distinction between dischargeable debt and the surviving lien on property can be important when the debtor surrenders the property, and the amount of the liens exceeds the value of the property.
John Smith owns a home with a value of $100,000 that is subject to mortgage liens totaling $150,000. Because these liens cannot be eliminated, or (generally) even bifurcated, if Smith intends to keep his home, he will have to pay the $150,000 in mortgages.
Once his Chapter 7 discharge is final, Smith will have no personal liability for the mortgages. The liens will, nevertheless, still attach to the home. Thus, if Smith wants to retain the home, he will still have to pay the mortgages. If he has defaulted on the mortgages, and he wants to reinstate them by paying the arrearage over time, he may have to file in Chapter 13.
Alternatively, Smith can surrender the home. If he does so, he will not be liable for the $50,000 mortgage deficiency, as he has no personal liability for the mortgages after the discharge.
Some states provide a somewhat similar provision. In some states, a debtor has no personal liability for a deficiency judgment that results from a foreclosure of a purchase-money mortgage.
Note that this state provision is very narrow in scope because:
- It only applies in some states.
- It only applies on purchase-money (first) mortgages. It usually does not apply to second mortgages, or refinancings, which are far more likely to cause a deficiency.
- For the provision to apply, the debtor must lose his or her home in foreclosure.
Nevertheless, debtors who face the loss of their home through foreclosure of a first mortgage should be aware that, in some states, it may be possible to eliminate any deficiency judgment, without resorting to bankruptcy. Debtors in this situation should consult an attorney on the best way to proceed in the particular state in question.
What are the after-effects of bankruptcy
When concluded, a bankruptcy filing remains on the debtor's credit report for 10 years. However, the damage to the debtor's credit rating may be mitigated by other factors.
For example, most debtors are unaware that FHA, the federal agency that insures millions of mortgages, has one of the most liberal polices concerning bankruptcy and me mortgages. Generally, the FHA only precludes debtors from obtaining a new FHA mortgage for two years from the discharge date of a Chapter 7 bankruptcy, provided the debtor has an otherwise acceptable credit standing during the two-year period. Because a home is typically the largest purchase individuals make, debtors should realize that financing for a new home may still be available shortly after the bankruptcy action is completed.
It is important to list all debts in a bankruptcy filing, as debts not listed cannot be discharged. However, some debtors retain a credit card with a very low (or no) balance, but a large credit line, by purposely omitting the debt from the filing, to ensure they will have future credit available. On the other hand, many banks periodically check customer's credit reports. If this is done, the card will likely be canceled anyway. Such an action could also jeopardize the bankruptcy discharge, for it smacks of fraud.
Any recent shuffling of debt from the card retained to the listed cards is likely to be attacked as fraudulent. This is especially true if it happened in the year leading to the bankruptcy. However, if planned well in advance, and before any financial difficulties arise, an extra card held in reserve will be effective. This card can be used only infrequently, and then only for small purchases, to keep it active.