Bankruptcy

The ?Forbidden Reason? For Pre-bankruptcy Spending

By Craig Andresen, Minnesota Bankruptcy Attorney

Every chapter 7 or chapter 13 bankruptcy filing involves a creditors meeting which occurs about one month after the case is filed.  This meeting can unexpectedly become the perfect storm where, if enough of the wrong factors jell together, the debtor may blurt out the “forbidden reason” for spending down his or her bank accounts before the bankruptcy was filed.

This is where the debtor testifies, with the tape recorder capturing every word, sneeze or other sound, that he or she spent the money so the trustee wouldn’t be able to take it.  Then, the room will turn silent while the bankruptcy trustee slowly opens the U.S. Code laying on the table.  The trustee will turn the page to section 727(a)(2) of the bankruptcy code, which reads:

The court shall grant the debtor a discharge, unless … the debtor, with intent to hinder, delay, or defraud a creditor or an officer of the estate charged with custody of property under this title, has transferred, removed, destroyed, mutilated, or concealed, or has permitted to be transferred, removed, destroyed, mutilated, or concealed … property of the debtor, within one year before the date of the filing of the petition….

This is the forbidden reason for spending down the bank accounts or other liquid cash prior to filing bankruptcy.  If the reason was to shield the money from the trustee or a creditor, the trustee has an excellent argument that the debtor should not receive a discharge in the chapter 7, or that the debtor’s chapter 13 plan was filed in bad faith.

You might wonder whose fault it would be it such a disaster were to actually happen.

Fortunately, this terrible scenario need never happen, because all the bankruptcy lawyer has to do is to carefully explain section 727 to every bankruptcy client before the case is filed, and before any spend-downs occur.

The point here is not that once the debtor knows about the forbidden reason announced in section 727, the debtor will testify untruthfully about his or her motives for spending down the funds.  Rather, the point is that the debtor will take especial care to testify truthfully about the reasons for the spend-down, and he or she will avoid citing the forbidden reason out of carelessness, without giving the true reasons.

For example, it ought to be obvious that the debtor bought groceries and clothing before the bankruptcy filing because her family really did need to eat, and they really did need some clothes to wear, and the debtor has been buying those things her whole life without any motive of defrauding creditors.  Similarly, the debtor caught up on house payments just before the bankruptcy filing because the family really did live in the house, and without making those payments the mortgage company would eventually see them living in the streets.

The bankruptcy lawyer’s having explained the exemption laws to the debtor doesn’t alter the fact that the debtor had solid, sufficient reasons for spending the funds in the manner he or she did just before filing bankruptcy.  And, when the debtor knows what section 727 says about the forbidden reason, the debtor certainly won’t be spending money before the bankruptcy filing in the manner described there.

Full post as published by Bankruptcy Law Network on April 30, 2010 (boomark / email).