The debtor may not “give away” money when he is insolvent, or prefer to pay one creditor at the expense of others. All creditors must be treated equally. Consequently, large payments made by a debtor before filing bankruptcy are often the subject of scrutiny by a Chapter 7 trustee.
Most pre-bankruptcy payments are protected. For instance, the trustee may not undo house or car payments because the debtor received something of reasonably equivalent value in return for the payment. On the other hand, paying a family member selling a car worth $5,000 to a close friend for $10 in order to protect it from the bankruptcy trustee is likely a fraudulent transfer that can be voided.
Sometimes trustees like to test the limits of their avoidance powers granted by the Bankruptcy Code. For example, in the recent case of Geltzer v. Our Lady of Mt. Carmel-St. Benedicta School and Geltzer v. Xaverian High School, No. 11-43773 (Bankr. E.D.NY., December 4, 2013), a Chapter 7 trustee sought turnover of pre-petition private school tuition payments totaling $46,562. The trustee claimed that because the parents were not “direct beneficiaries” of the tuition payments, and the private schooling was “not reasonably necessary,” the debtors did not receive reasonably equivalent value or fair consideration for the tuition payments as required under Sections 548(a)(1)(B) and 544(b) of the Bankruptcy Code, and portions of New York state law. The trustee asked the bankruptcy court to find that the payments were fraudulent conveyances and compel turnover of the money for fair distribution to creditors (along with a nice little payday for himself).
The bankruptcy court judge (who was appalled by the trustee’s motion) denied the request and stated that the trustee’s claims were “based on a fundamentally flawed legal theory that is . . . at odds with common sense.” The court ruled that “the Debtors and their minor children must be viewed as a single economic unit,” and noted that parents are legally obligated to provide their children with life’s necessities. The choices parents make while executing this obligation cannot be subjected to later review by bankruptcy trustees:
The fact that they chose [to send] their children to private or parochial school . . . does not render the payments subject to scrutiny by the Trustee for avoidance, any more than the Trustee would be entitled to second-guess other choices made by debtors pre-petition in providing clothing, food [or] shelter . . . to their minor children.
Common sense prevailed in this case, but there are many potential stumbling blocks along the road to a bankruptcy fresh start. A review of transfers and payments is part of the pre-bankruptcy process. You should inform your bankruptcy attorney of all transfers of property and money, large or small, so that your legal and financial interests can be protected.