Actions on the eve of bankruptcy will many times determine the availability of the fresh start: a new financial life free of debt with some exempt assets. Debtors push the envelope on exemption planning because the legislative history of the Bankruptcy Code emphasizes that the conversion of nonexempt assets to exempt assets for the purpose of placing assets outside of creditors block is not, without more, a fraudulent transfer.¹ Lawrence Pondroff and F. Stephen Knippenberg assert that "...courts and commentators have been unprincipled and inconsistent in their attempts to describe when and why such pre-bankruptcy conversions are permissible."² Other commentators have been more colorful: "Fraud in bankruptcy planning appears to enjoy the same precise definition as pornography; the federal courts know it when they see it."³ In three recent cases, courts have continued to address the lack of a predictable outcome.

In the case of In re Crater,⁴ the debtors engaged in exemption planning once a creditor commenced legal action against them. The debtor's attorney warned the creditor's attorney that bankruptcy would result. The debtors sold non-exempt property and applied the $40,000 proceeds to the second mortgage on their homestead. The bankruptcy filing followed within 17 days. The creditor objected to discharge and moved for summary judgment alleging circumstantial evidence supported "actual intent to hinder, delay or defraud."

The Crater court focused on whether the transfer effecting the exemption was made with actual intent, either to defraud or to hinder or delay, as shown by a preponderance of the evidence. Relying on In re Woodfield,⁵ the Crater court found that actual intent can be inferred from circumstantial evidence. Because this was a summary judgment motion, the creditor had the burden of establishing that a trier of the fact could not conclude the debtor's intent was innocent.

The court began its analysis of intent by dividing the badges of fraud into the following three categories: (1) those indicating an act of fraud, (2) those indicating motivation and (3) those indicating suspicious factors. The court then found that the creditors had only raised suspicious timing factors. Neither the timing of the transaction nor lack of an economic basis for the transaction were elevated by the Crater court to a rule that would prevent pre-exemption planning. The court cited legislative history and In re Smiley⁶ in deciding that the standard should not limit the debtor's right to maximize exemptions "...unless the creditor shows a deception or concealment, an insider transaction, a fraudulent conveyance, a secretly retained possession or benefit, or debtor's explanations lack credibility...," concluding that suspicious acts or timing will not defeat a discharge.

Complaining about the same lack of a coherent body of law on exemption planning, another court came down on the other side of the question in the same time frame in In re Boudrat.⁷ The debtors in Boudrat were subjected to entry of a $71,000 judgment. Shortly after that, they liquidated $54,000 in nonexempt assets and applied the proceeds to their homestead mortgage. After the bankruptcy filing, the judgment creditor contested the discharge. At trial, the following facts were established: (1) at the time of the transfer, the debtors knew of the judgment; (2) the debtors knew the transfer would deplete all their available cash; and (3) the debtors had no credible bankruptcy planning reason for the transfer except to place assets beyond the creditor's reach.

Relying on Tenth Circuit cases,⁸ the Boudrat court found that the debtors had the requisite intent to hinder or delay creditors, which was evidenced by their stated purpose to place the assets beyond the reach of creditors even though it was done with advice of counsel. The court emphasized that the "defendants made this transfer just shortly after entry of the state court judgment against them without any credible statement of an intent to engage in bona fide bankruptcy planning" and that the "defendants appear to harbor animosity toward the plaintiff."⁹ It is fair to conclude that this court knows fraud when it sees it.

It is apparent that the test for successful pre-bankruptcy planning is a gray one: "If the debtor has a particular creditor or series of creditors in mind and is trying to remove his assets from their reach, this would be grounds to deny the discharge. If the debtor is merely looking to his future well-being, the discharge will be granted."¹⁰

That test is made even more vague by a recent Wyoming decision, In re Baker.¹¹ After noting that Wyoming is an "opt-out" state, the court went on to find many badges of fraud even though debtors liquidated non-exempt assets to create exemptions to protect their financial future. The creditor's actions arose from the debtor's guarantee of their children's debts. Even though the debtors acted openly and with the advice of counsel, the court denied the discharge, stating that there might be permissible exemption planning to increase the value of a homestead exemption, but not when a debtor shields almost all of their valuable assets and then files bankruptcy. This result is consistent with In re Kulwin,¹² where the court denied the debtor a discharge and a "running start" where a large amount of property was converted to exempt property, and only certain creditors were paid. The court concluded that any other result would be a "perversion" of bankruptcy law.

Perhaps the commentators are right about the inconsistent case law surrounding the transmutation of assets. Legislative history states that there is nothing inherently wrong in adjusting assets to maximize exemptions. Creditors, whose rights normally arise from contracts, do not bargain for exempt property. Perhaps asset-conversion to preserve exemptions should be reconceptualized as a property right in order to preserve a fresh start.¹³

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Footnotes

¹ H.R. Rep. No. 595, 95th Cong., 2d Sess. 361 (1977); S. Rep. No. 989, 95th Cong., 2d Sess. 76 (1978). Return to article

² Pondroff, Lawrence and Knippenberg, F. Stephen, "Debtors Who Convert Their Assets on the Eve of Bankruptcy," 70 N.Y.U. L. Rev. 235, May 1995. Return to article

³ Norwood, John M. and Jennings, Marianne M., "Before Filing Bankruptcy, Move to Florida and Buy a House," 28 SW. U.L. Rev. 439, 442 (1999). Return to article

⁴ 286 B.R. 756 (Bankr. D. Ariz. 2002). Return to article

⁵ 978 F.2d 516, 518 (C.A. 9 1992). Return to article

⁶ 864 F2d 562 (C.A. 7 1989). Return to article

⁷ 287 B.R. 582 (Bankr. W.D. Okla. 2002). Return to article

⁸ In re Carey, 938 F.2d. 1073 (10th Cir. 1991); In re Serafini, 938 F2d. 1156 (10th Cir. 1991). Return to article

⁹ 287 B.R. 582, 587. Return to article

¹⁰ In re Oberst, 91 B.R. 97, 101 (Bankr. C.D. Cal. 1988). Return to article

¹¹ 273 B.R. 892 (Bankr. D. Wyo. 2002). Return to article

¹² 187 B.R. 341 (Bankr. D. Kan. 1995). Return to article

¹³ Pondroff and Knippenberg at 324-35. Return to article