In the complaint, prosecutors allege that Dykstra sold or destroyed over $400,000 worth of property.  Among the property that Dykstra allegedly sold – presumably to raise case – were sports memorabilia and furnishings from the home he lost in the bankruptcy.

Obviously most of the Chapter 7 cases filed in the Northern District of Georgia, or in most bankruptcy courts do not involve millions of dollars of debts incurred by a high profile debtor.  However, there is an important lesson that all bankruptcy filers can learn from the charges levied against Mr. Dykstra.

When you list assets on your bankruptcy petition, you are swearing that this list is accurate under penalty of perjury.  If your trustee discovers that items have been omitted, or worse, that they have been secretly sold, the trustee will refer the case to the U.S. Attorney for prosecution.

Sometimes, I overhear conversations in bankruptcy court in which a debtor expresses frustration with the bankruptcy process or anger at an ex-wife, a former business partner or even a former employer.  I also hear conversations expressing frustration with the rather stingy dollar limits set out in the Georgia exemption statute.   I sense that some bankruptcy filers believe that the circumstances that led to their having to file were unfair and out of their control and as such leaving out inherited jewelry that “no one will ever know about” or selling a few items for cash can be rationalized.

While it is probably true that Chapter 7 trustees generally do not have the resources to thoroughly investigate every Chapter 7 debtor, I caution any bankruptcy filer not to take the risk.

First and foremost, an intentional failure to disclose assets is illegal and constitutes a crime under federal law.  No asset is worth your freedom or personal integrity.

Second, you have no way of knowing if the United States trustee will select your case for a random review which can also mean much more intrusive scrutiny.

Third, it is possible that a third party – often an ex-wife or ex-business partner – might anonymously write the U.S. Trustee to report intentional errors on your petition.

Fourth, you might fall victim to “Murphy’s law” – your trustee or someone from his office might see you walk into a pawn shop or might see your auction on eBay.   Believe it or not, these types of coincidences do happen.

Often, issues associated with assets that you cannot protect can be resolved if you do not have to file right away.   While the bankruptcy laws can be unforgiving, they will not punish you if you sell assets to raise money for food, shelter and clothing, as long as those sales are disclosed when applicable.  This is why I advise anyone who is even remotely considering bankruptcy to speak with a bankruptcy lawyer at the earliest possible date.  In my office, I regularly maintain files in “pre-bankruptcy” status for four, six, eight months or longer.  Often the delay arises from my client’s need to gain lawful benefit from assets that would be seized if the case was filed early.

Because the bankruptcy process can seem informal, it can be easy to forget that a Chapter 7 or Chapter 13 filing is made up of documents filed in a federal district court and subject to investigation by the F.B.I.

Attorney Gini Nelson, a New Mexico bankruptcy lawyer, recently published a post about bankruptcy fraud in the Bankruptcy Law Network blog.  Gini’s post includes a link to the IRS.gov site containing examples of bankruptcy fraud investigations.   I found the IRS.gov link especially interesting in that one can get a sense of the type of fraud that bankruptcy debtors have attempted and the level of fraudulent activity that generated prosecution.  Given the highly interconnected and electronic public record access that is available to bankruptcy trustees as well as government investigators I can’t believe any of these folks believed that they would not be caught.

I bring this case to your attention for several reasons.  First, you should recognize that Chapter 7 trustees are very conscious of the likelihood that a certain percentage of debtors will fail to disclose assets.  While it may seem that your Chapter 7 trustee is not paying much attention to any particular case, I suspect that trustee training programs provide trustees with profiles of the types of debtors likely to omit important information as well as resources to search for evidence of hidden assets.

In the Texas debtor’s case I wonder how he thought that a vehicle sale would be missed by the trustee, given that vehicle liens are public record, as are vehicle registrations.

These days almost any sale of real estate or motor vehicles will generate a paper trail of tax forms, insurance records and title documents.  Further I have personally seen situations where an unhappy ex-wife or a former friend will draft a “poison pen” letter to the trustee will allegations about improper activities by a bankruptcy debtor.

Second, be aware that Chapter 7 trustees and the U.S. trustee like to pursue fraud cases periodically to send a message to debtors and debtors’ lawyers that the trustees are paying attention.   Bankruptcy lawyers may be tempted to say “don’t worry about it,” to avoid extra expense and complication but playing fast and loose with disclosure rules can create major problems for both debtors and their lawyers.

Occasionally I meet with a client who may say something like “between you and me, no one knows this but….”    This type of statement is the last thing that any bankruptcy lawyer wants to hear.  From my perspective that client is really saying “I am thinking about committing a federal crime and I want you to help me.”  My license to practice law is not worth the fee for any one case and I have and will continue to decline representation for any client who wants to use my office to file inaccurate schedules.

Nobody likes to surrender assets, especially in a bankruptcy case that may have come about because of factors beyond one’s control (such as a layoff, unfair treatment by a lender, a lawsuit judgment that you did not know about).   In most bankruptcy cases you will not lose in assets.   However, losing a few hundred or thousands of dollars is a far better fate than federal prison.

My Bankruptcy Law Network collegue Susanne Robicsek answers this question clearly and consisely in a 2007 post on the BLN blog.  Susanne’s advice remains valid – do NOT pay back a personal loan prior to filing bankruptcy without first talking to a bankruptcy lawyer.

There are two potential issues if you pay back mom or dad, or the next door neighbor.  First, there is the problem of “preferences.”   Congress recognized that debtors would be tempted to favor certain creditors in a pre-bankruptcy setting.   The bankruptcy code contains a section that addresses so called “preferential” payments on old debts. A payment to an “insider” – think relative or business partner – is a preference if issued within one year before the bankruptcy filing.  A payment to a non-insider falls within the preference definition if issued within three months.  The only real defense to a preference allegation is the “ordinary course of business” argument, but that is a difficult road, especially in the case of personal loans.

Typically a preference action will be brought by the trustee.  If successful the trustee will be authorized by the bankruptcy judge to compel the recipient of the payment to tender that money to the bankruptcy estate for distribution to creditors.  Needless to say, mom or dad will not be happy to get a letter from your trustee demanding payment of that $5,000 you repaid them 8 months prior to filing.

A second, even more serious issue, can also arise if you pay money to a relative or friend.  Transfers of property prior to bankruptcy that are made to shield your money from creditors may be considered a fraudulent transfer.  This is a much more serious transgression and can result in a denial of your discharge.   The lookback period for a fraudulent transfer per the bankruptcy code is 2 years.

Bottom line: if you think that bankruptcy is even a remote possibility, talk to a bankruptcy lawyer before making any lump sum payments or repayments to anyone.

Mr. Marrama filed a Chapter 7, but failed to disclose on his schedules that he had put title to a Maine vacation house into a trust. He also failed to disclose an income tax refund.  Interestingly, it appears that Mr. Marrama did reveal the existence of the house, but listed his ownership interest (equity) as zero.

The Chapter 7 trustee checked property records and discovered the transfer (it is unclear to me when this transfer occurred, although the transfer itself does not seem to be an issue here).  The trustee filed a motion to undo the transfer and take title to the house for the purpose of selling it.

Mr. Marrama then moved to convert his case from Chapter 7 to Chapter 13.  The trustee objected and the bankruptcy judge ruled against Mr. Marrama as did several other appeals courts.  The case eventually made its way to the Supreme Court, where Justice John Paul Stevens writing for the majority, stated that while honest debtors were entitled to convert their Chapter 7 cases to Chapter 13, a bankruptcy judge is entitled to take away that right because of “fraudulent conduct.”

The case will be sent back to Massachusetts where Mr. Marrama will no doubt lose all of his non-exempt property.  Chapter 7 cases cannot be dismissed without permission of the court and this is clearly not a case where such permission will be granted.

The point here – it is vital that you reveal all of your assets and debts to your attorney and to the courts.  Over the past few years, the United States trustee and Chapter 7 trustees have become much more vigilant in looking for assets.  Recently one of the attorneys for the United States trustee told me that her office’s goal is to push people out of Chapter 7 and into Chapter 13.  Chapter 7 trustees are being strongly encouraged to look closely for hidden assets.

Thanks to Scott Sagaria of the California Bankruptcy blog for writing about the Marrama case.

The Bankruptcy Code gives trustees the right to recover fraudulent transfers and Section 727 of the Code makes a fraudulent transfer grounds to deny a debtor’s discharge.

I think that fraudulent transfer cases can be especially dangerous because the law that has developed around this area often defies common sense.  Often the neither the debtor nor the transferee has any bad intention and, in the 11th Circuit, you cannot "undo" the transfer.  Attorneys not famliar with this area of the law are often surprised at the harsh results that follow.

I recently came across a case out of Ohio that illustrates how unforgiving the fraudulent transfer law can be.  The Ohio case involved a situation where a young man transferred title to a motorcycle to his father.  The young man’s wife did not like having the motorcycle around.  The father never drove the motorcycle nor did he ever insure it.   My guess – although the case does not say this – is that the son periodically drove the motorcycle away from the watchful eye of his wife.

In any case, the father found himself in financial trouble and in need of bankruptcy relief.  Prior to filing the father "gave" the motorcycle back to his son.

When the father filed bankruptcy, the trustee asserted that the transfer was fraudulent and demanded that the motorcycle be turned over to the bankruptcy estate.  The Ohio bankruptcy judge agreed with the trustee and found that the transfer was, indeed fraudulent.

My collegues in the Bankruptcy Law Network have written extensively about fraudulent transfers and I urge you to review their postings.   The point here – if you are considering bankruptcy, think hard about any transfer that you might have made even if you never really considered the property to be yours.  These type of "oh, by the way" matters are the statements that keep bankruptcy lawyers up at night.

For example, in Georgia, you can shelter $5,000 in household goods, as long as no individual item is worth more than $300.  Therefore, for practical purposes, your television, stereo, clothing, clock radio, etc. is not at risk.

One of the most important exemptions has to do with your home.  In Georgia, you can shelter $10,000 of equity in your home ($20,000 of equity if you file jointly with your spouse).  In other States, however, the "homestead exemption" may be much larger.  For example, in Florida, your can declare as exempt 100% of your equity.

Thus, two identical debtors, one who lives in Georgia and one who lives in Florida, could have very different bankruptcy experiences. The Florida debtor could own a $250,000 house free and clear and still qualify for Chapter 7 without risking his house, whereas the Georgia debtor would lose his house to the trustee.

Because of this disparity in exemption rules, Congress changed the Code to provide that a debtor who moves from one State to another must use the first State's exemption laws for two years.  After he has been a resident of the new State for two years, he must use the new State's laws.  The purpose of this change was to stop people from moving to States like Florida to shelter their assets in real estate.

Florida attorney Jonathan Alper raises an interesting question in his blog about what happens if an individual moves to Florida, buys a house then encumbers his new homestead with a home equity line of credit in his spouse's name.  Jonathan has one opinion about the repurcussions and I have another, but the point here is that when new rules are created, there are always going to be fact patterns that no one expected and that may result in unexpected or undesireable results.  My sense is that there are going to be a lot of these unknowns in the new law and we are just starting to see some of them work their way up the appellate system.  My colleague Scott Riddle publishes a blog that looks at some of these new developments in the law and I read it regularly to keep up to speed. 

Technorati Tags: georgia exemptions, O.C.G.A. 44-13-100, filing bankruptcy in new State, Jonathan Alper

The last paragraph of Scott's post merits repeating:

The lesson to debtors is, obviously, disclose all of your assets and answer all questions truthfully (truth + fully).  You cannot over-disclose to your lawyer or on the schedules.  For debtors' counsel, explain the criminal and civil (bankruptcy) penalties for false schedules, and get a signed statement that it has been explained.  It can't be good marketing when a client is denied a discharge and gets indicted, especially if the client defends by claiming he/she didn't understand what is supposed to be disclosed.

All of us who represent stressed out and anxious debtors have heard a request that "let's just keep this between the two of us" and a confession about some hidden asset or loan repayment (in cash) to a relative.  My response, as would be the response of most of my colleagues in the consumer bankruptcy bar, is to the effect that (1) I am an officer of the Court and I will not participate in a scheme to mislead the bankruptcy court and (2) I am not going to put my livelihood in jeopardy for any client, ever.  

In the case discussed in Scott's blog entry, the omitted assets would not have created a problem for the debtor, but the judge or trustee in that case sent the file to the U.S. Attorney for criminal prosecution for Bankruptcy Fraud.  Because the debtor intended harm, he committed a crime – and ended up serving time in federal prison.

So, if you are considering bankruptcy, keep in mind this requirement of total and complete disclosure of all information, good, bad or indifferent.

Technorati Tags: bankruptcy disclosure, criminal penalty for bankruptcy fraud, failure to disclose assets in bankruptcy filing

Bankruptcy Code Section 547 empowers the trustee to avoid a transfer (preference) between the debtor and an insider on account of an antecedant (pre-existing) debt if the payment was for a debt incurred within one year of the bankruptcy filing.

Bankruptcy Code Section 548 empowers the trustee to avoid a “fraudulent” transfer to any party within two (2) years of the bankruptcy filing – fraudulent being defined in the Code Section as essentially a transfer made with actual intent to hinder a creditor or for less than full value and made when the debtor was insolvent. Prior to October 17, the lookback period in this section was one year, not two years.

Finally, Bankruptcy Code Section 727 authorizes the Court to deny a discharge to a debtor who, with the intent of defrauding creditors or the estate, has transferred property within one year of filing.

I have a case where my potential client had borrowed assets from an insider to use as security for a bank loan. He never took out the bank loan and therefore never made use of the loan of the assets. When it became obvious that he would not need the bank loan, he then transferred that property back to the insider a year and two months ago.

The insider had requested the return of the assets once it became clear that my client would not need them. The transfer was made when the debtor was insolvent.

Does it make a difference that the debtor’s transfer was in the form of a debt repayment (vs. an outright transfer)? Is there a different standard of review if a “preferential” transfer is outside the preference period but within the fraudulent transfer period? Would this return of assets be considered “ordinary course of business.” Should I list it on Question 10 of the Statement of Financial Affairs?

Thoughts?