Protecting Assets while Avoiding Bankruptcy Fraud

The United States Bankruptcy Code controls the entire bankruptcy process. Bankruptcy laws are meant to protect you and your creditors. Bankruptcy fraud is a white-collar crime that typically involving concealment or transfer of assets, concealment or destruction of documents, conflicts of interest, fraudulent claims, false statements or declarations, and fee fixing or redistribution arrangements. If you’re caught committing bankruptcy fraud, you could face a fine of up to $250,000 and a sentence of up to five years of incarceration. This exposure makes the timing of any type of asset protection strategy by debtors critical because the fraudulent transfer rules pose the biggest obstacle to effective asset protection planning in bankruptcy. If a debtor makes a transfer and then files too soon for bankruptcy, the trustee can claim the transaction constitutes a fraudulent transfer which may make that asset available for distribution to creditors.

What Can Make Transfers Fraudulent

Chapter 726 of the Florida statutes defines a Fraudulent Transfer as follows: A transfer made, or obligation incurred by a debtor, that is intentionally fraudulent to a creditor, whether the creditor’s claim arose before or after the transfer was made or the obligation was incurred, if the debtor made the transfer or incurred the obligation, with intent to hinder, delay or defraud the creditor; or without receiving a reasonably equivalent value in exchange for the transfer or obligation. Timing of the transfer is extremely important, and depends on the amount of the exemption and the circumstances surrounding the conversion; especially when the conversion amounts to nothing more than a temporary arrangement. A transfer in good faith and for reasonably equivalent value is not voidable or fraudulent. Although, even in good faith, the creditor is still entitled to a lien on the asset transferred, to enforce any obligation incurred, or to reduce the amount of the liability on the judgment.

Legitimate Asset Protection Strategies

Debtors considering bankruptcy may wonder how they can protect assets legally and not commit bankruptcy fraud at the same time? The single best asset protection planning technique is to invest in a homestead. Florida’s Debtor Homestead Protection Laws are some of the most liberal in the country. The value of the property that can be protected is unlimited provided the property occupies no more than ½ acre (2,000 m²) within a municipality or 160 acres (650,000 m²) outside of a municipality. Florida’s homestead exemption attaches to proceeds from the sale of a home if those proceeds establish a new Florida homestead within a reasonable time (1215 day limitation). This protection is lost if the funds are commingled with funds not designated for that purpose. The four types of creditors that can still force the sale of a homestead to collect debts owed to them include government agencies collecting past due property taxes, creditors on a mortgage, contractors with claims for repairing or improving the property, or any lien holder with a lien that pre-dates the homestead (condominium and mandatory homeowner association liens).

A second asset protection planning technique is investing in retirement plans, 529 plans, SEPs, IRAs, annuities and all life insurance policies. Timing is extremely critical here. If someone has an “event” that they think could lead to liability like a personal injury lawsuit, then converting “reachable” assets into “exempt” assets could be a fraudulent transfer. The life insurance exemption is extremely broad and extends not only to the insured’s creditors but to the beneficiary’s creditors. This may not be true for assets purchased with insurance proceeds. The Reform Act limits an individual’s exemption for IRAs and SEPs to $1,000,000 (aggregating all such accounts and plans) but not to qualified retirement plans or amounts rolled over from such plans to an IRA or SEP. It is unclear how appreciation is handled after rollover, but the way to address that uncertainty is to maintain segregated accounts.

A third asset protection strategy is for spouses to split marital property assets, so that each receives a share as separate property. Then each spouse’s separate property assets are only exposed to that spouse’s creditors. Even though the couple is not transferring any assets to outside parties, a partition can be considered a fraudulent transfer if done with the intent to delay, hinder or defraud a creditor. Therefore, it is important that neither spouse be insolvent as a result of the partition since exempt assets are excluded from the solvency test. This means that such transfers should leave some reachable assets when partitioning marital assets. There are important consequences of a partition. First, a partition agreement can have significant consequences at time of divorce in terms of the distribution of marital property. One additional drawback to a partition agreement is that spouses potentially lose part of their step-up in basis as a decedent (Internal Revenue Code Section 1014).

A fourth asset protection strategy is to form family limited partnerships (FLP), where assets held in a partnership are difficult for a creditor to reach. A creditor of a partnership generally can only obtain a charging order against a partner’s interest in a partnership and not directly for the assets in the partnership. One of the obvious downsides for the debtor in an FLP is the he or she would not be able to receive any distributions from the partnership while the creditor has a charging order on the partnership interest. However, the family members might be able to receive management fees or other compensation from the partnership.

A fifth asset protection strategy is to form asset protection trusts (also called self-settled spendthrift trusts). These trusts are intended to allow people to contribute assets to a trust beyond the reach of their creditors but retain the right to receive distributions from the trust. These trusts must be irrevocable to protect the debtor from their creditors. With respect to an irrevocable trust, a creditor or assignee of the settler may reach the maximum amount that can be distributed to or for the settler’s benefit. If a trust has more than one settler, the amount the creditor or assignee of a particular settler may reach may not exceed the settler’s interest in the portion of the trust attributable to that settler’s contribution. (Florida Statutes Section 736.0505(1)(b)).

Lastly, a sixth asset protection strategy is to create a domestic asset protection trust. Certain foreign jurisdictions such as the Cayman Islands and Isle of Mann began the process of altering traditional trust law to allow self-settled trusts to avoid the reach of creditors. As these offshore trusts became more and more popular, people started transferring vast amounts of wealth offshore. As states saw all of this money flowing to offshore jurisdictions, some decided that they should not be bound by these traditional trust law concepts either. Approximately 17 states have passed laws allowing asset protection trusts in their states. Florida did not pass this law, but did consider it in 2010.

The bottom line is that there are a number of asset protection strategies that may be used by those that need to seek bankruptcy protection but the transactions must be structured carefully. An experienced Florida bankruptcy attorney can provide valuable legal advice so that you do not inadvertently become exposed to criminal liability or risk having a fraudulent transfer unwound by the bankruptcy trustee.