Cite as: Keith M. Lundin, Lundin On Chapter 13, § 105.2, at ¶ ____, LundinOnChapter13.com (last visited __________).
The transfer of assets on the eve of bankruptcy is a lightning rod for intense scrutiny of the debtor’s good faith.1 Creditors build a convincing good-faith objection to confirmation by demonstrating that the debtor tried to put assets out of reach immediate to the filing. Finding such transfers requires careful work. Comparison of the debtor’s statement and schedules with financial statements the debtor gave before bankruptcy may reveal transferred or missing assets.
Debtors sometimes have to be pushed hard by their lawyers to reveal transfers that could be interpreted as evidence of bad faith.2 Hiding or poorly describing a suspicious prepetition transfer is a dead giveaway guaranteed to make a bad situation worse. The best the debtor can do is to honestly and completely reveal the transfer. If possible, a transfer that really stinks should be undone. A prepetition transfer might have to be recovered as a preference or fraudulent conveyance.3 One of the advantages of Chapter 13 is that the debtor can often control the decision whether to recover a questionable transfer or compensate creditors through the plan for the value of the transferred property.4 For example, if the debtor suspiciously conveyed real estate to a family member, the debtor can either undo the transfer or propose to compensate creditors through the plan for the value of the property. The Chapter 13 plan that fails to fully compensate creditors for value lost through an avoidable prepetition transfer will also fail at confirmation because of the best-interests-of-creditors test in § 1325(a)(4).5 A few reported decisions make the point that prepetition transfers of property by the debtor are a factor in good-faith analysis, but are not preclusive of good faith, even when the transfer is avoidable in the Chapter 13 case.6
Many courts have questioned good faith when the debtor acquired assets or borrowed money just before filing and the plan seems to compound the indiscretion.7 The gist of these cases is that debtors sincerely in need of Chapter 13 relief should not be buying new cars or new homes or borrowing large sums of money on the eve of filing. Especially telling is evidence that the debtor consulted with bankruptcy counsel and then bought a car or borrowed money. If the debtor has recently acquired any significant asset, counsel should advise the debtor to surrender the new acquisition as part of the plan.8 Creditors can examine the schedules to identify significant debts recently incurred or property recently acquired.
There is a sometimes fine line between legitimate prepetition financial planning9 and prepetition conduct indicative of irresponsibility by the debtor. For example, one court found that the selective payment of unsecured creditors, with the purpose of creating eligibility for Chapter 13 relief, was evidence of bad faith.10 Although conversion of assets into exempt property on the eve of bankruptcy is sometimes permitted by state law, it may nonetheless be evidence that good faith is lacking at confirmation of a Chapter 13 plan.11
1 See, e.g., Hardin v. Caldwell (In re Caldwell), 895 F.2d 1123 (6th Cir. 1990) (pattern of deceit and delay, including efforts to reduce assets available to creditors); Beard v. U.S. Trustee (In re Beard), 188 B.R. 220 (W.D. La. 1995) (Lack of good faith included that debtor pawned property and lost or damaged collateral before filing petition.); In re Nittler, 67 B.R. 217 (D. Kan. 1986) (It is evidence of bad faith that debtor transferred a mortgage to a family member on the eve of bankruptcy.); In re Hendricks, 250 B.R. 415 (Bankr. M.D. Fla. 2000) (Conversion of assets into exempt homestead after entry of large judgment coupled with 0% plan support finding that plan is not proposed in good faith.); In re Larson, 245 B.R. 609 (Bankr. D. Minn. 2000) (Evidence that the debtor fraudulently conveyed real property prior to the petition with actual intent to hinder, delay or defraud creditors weighs strongly against a finding that the debtor’s composition plan is a sincere effort at repayment.); In re Mattson, 241 B.R. 629, 637–38 (Bankr. D. Minn. 1999) (After entry of state court judgment for racial discrimination, debtors “transferred a substantial portion of their assets to a newly formed corporation for little or no consideration and quit claimed property to a relative. . . . The Debtors then began to file numerous mortgages against their real property in favor of their relatives and a friend. . . . During the pendency of their [prior two bankruptcies], the Debtors manipulated the bankruptcy code and the automatic stay. . . . The sum of the activities prior to the filing of the present bankruptcy causes me to seriously doubt the Debtors’ motivation and sincerity in seeking bankruptcy relief.”); In re Kurtz, 238 B.R. 826, 830–31 (Bankr. D.N.D. 1999) (Transfers of assets to family members and friends on the eve of adverse judgment in state court demonstrated a lack of sincerity in 7.2% plan that would compromise large nondischargeable claim. Before $209,808 judgment for assault on a girlfriend, debtor transferred a condominium to himself and his parents as joint tenants. After judgment, the debtor transferred a lake property to himself and his parents. The debtor also transferred a power boat and a snowmobile to his current girlfriend. “The Court is left with the impression that the transfers of both the condominium and the lake property were motivated solely by the specter of the civil judgment. . . . The fact that Kurtz, by his own actions, no longer possesses any significant assets coupled with the meager plan payments militates against his assertion of repayment sincerity.”); In re Baird, 234 B.R. 546 (Bankr. M.D. Fla. 1999) (Lack of good faith is based in part on debtor’s prepetition divorce agreement in which he transferred all material marital assets to his ex-spouse and agreed to pay her most of his net income each month in alimony. Court found that prepetition divorce agreement was part of a plot by the debtor to diminish recovery by a creditor with a substantial fraud claim.); In re Ross, 231 B.R. 635, 638–39 (Bankr. S.D. Ohio 1999) (Plan is proposed in good faith notwithstanding prepetition dishonest conduct. “Mr. Ross has engaged in highly questionable pre-petition conduct. . . . [H]e sold grain in the names of other parties to avoid paying the Creditor that claims a security interest. . . . [S]ome equipment subject to the Creditor’s security interest has been sold without its permission. . . . $8,000 in cash on hand at the date of filing has been spent for crop inputs and living expenses, even though it is subject to the Creditor’s alleged security interest. . . . [H]e failed to include all farm income on his tax returns based upon the sale of grain in the names of others. . . . While such actions are not to be condoned, . . . [t]he debtors appear to be sincerely trying to repay their creditors while maintaining farm operations. It is the Court’s conclusion that the Debtors were doing everything possible to maintain their family and to maintain the farm operations, even at the cost of engaging in activities that are less than honest. The Court views their actions not as fraudulent but as misguided, and for this reason cannot find that they should be denied bankruptcy relief.”); In re Petersen, 228 B.R. 19, 22 (Bankr. M.D. Fla. 1998) (Debtor’s prepetition unsubstantiated disposition of substantial assets and income was evidence of lack of good faith. Debtor lived a “luxurious life in California.” In 1995, he earned $541,747 in salary, bonuses and stock options as an executive at Disney Corporation. Debtor listed a Lamborghini that was firebombed. Debtor claimed to have used the insurance proceeds for attorney’s fees. Debtor “previously owned Rolls Royces, one of which he claims to have given a workman in exchange for some repairs done on his California home which he claims was extensively damaged due to mudslides. No proof other than Debtor’s questionable testimony was offered to support these contentions.” Debtor sold his half-interest in a lot in Florida to his wife and used the proceeds for living expenses, medical debt, credit card expenses and funeral expenses. Debtor paid “large sums of money for psychological care and for protection through hiring bodyguards.”); In re Famisaran, 224 B.R. 886, 891–92 (Bankr. N.D. Ill. 1998) (Plan failed good-faith test in part because debtor failed to disclose “numerous checks that were made payable to the Debtors’ daughters . . . numerous undisclosed checks to Hollywood Casino” and the debtor failed to “credibly explain these expenditures.”); In re Chappell, 224 B.R. 507 (Bankr. M.D. Ga. 1998) (Prepetition unauthorized trade-in of 1966 truck for a 1967 truck not indicative of bad faith because lienholder was not injured.); In re McLaughlin, 217 B.R. 772 (Bankr. W.D. Tex. 1998) (One day before filing, debtors executed stock purchase option agreements restricting marketability of stock in a health care business.); In re Wainwright, 85 B.R. 456 (Bankr. N.D. Ohio 1988) (involving bad-faith transfer of property to debtor on eve of filing); In re Robertson, 84 B.R. 109 (Bankr. S.D. Ohio 1988) (involving bad-faith transfer of $33,000 to family-owned charitable ministry on eve of filing); In re Chrzanowski, 70 B.R. 447 (Bankr. D. Del. 1987) (Bad faith is indicated when debtor transferred large amounts of cash to family members before filing the petition.); In re DeReus, 53 B.R. 362 (Bankr. S.D. Cal. 1985) (Prebankruptcy preferential payments are not alone conclusive of bad faith, but bad faith is demonstrated when debtor failed to account for nearly $44,000 in cash transferred immediately before bankruptcy.); In re Wall, 52 B.R. 613 (Bankr. M.D. Fla. 1985) (Bad faith was demonstrated when debtor removed assets from reach of creditors, then filed Chapter 13 merely to defeat the claims of a judgment creditor.); In re Weyand, 33 B.R. 553 (Bankr. D. Colo. 1983) (Prebankruptcy fraudulent conveyances are sufficient bad faith to deny confirmation.).
2 See § 36.1 [ Statement of Financial Affairs ] § 36.22 Statement of Financial Affairs.
3 The debtor may be without authority to recover most prepetition transfers. See § 53.1 [ Strong-Arm Powers, Statutory Liens, Preferences and Fraudulent Conveyances ] § 50.3 Strong-Arm Powers, Statutory Liens, Preferences and Fraudulent Conveyances. The trustee can recover preferences or fraudulent conveyances. See § 60.1 [ Avoidance and Recovery Powers ] § 53.12 Avoidance and Recovery Powers.
4 See § 4.13 [ Fraudulent Conveyance or Preference Problems ] § 8.15 Fraudulent Conveyance or Preference Problems.
5 See §§ 60.1 [ Avoidance and Recovery Powers ] § 53.12 Avoidance and Recovery Powers and 160.1 [ In General: Plan Payments vs. Hypothetical Liquidation ] § 90.1 In General: Plan Payments vs. Hypothetical Liquidation.
6 See, e.g., In re Presley, 201 B.R. 570, 574 (Bankr. N.D. Fla. 1996) (“[T]he transfer of the Marion County property to [the debtor’s] sister within five months of filing for bankruptcy may be preferential, but should not be considered as fraudulent.” Applying Kitchens v. Georgia Railroad Bank & Trust Co. (In re Kitchens), 702 F.2d 885 (11th Cir. 1983) factors, court finds good faith notwithstanding that plan will discharge attorney’s fees and court costs that may be nondischargeable in a Chapter 7 case.); In re Allard, 196 B.R. 402, 415 (Bankr. N.D. Ill.) (That the debtor conveyed property into tenancy by the entireties before filing the Chapter 13 case “does not prevent the court from finding that the plan was proposed in good faith.”), aff’d, 202 B.R. 938 (N.D. Ill. 1996). Compare In re Smith, 196 B.R. 565, 573 (Bankr. M.D. Fla. 1996) (“Debtor’s plan fully discloses that he mistakenly made payments to two creditors outside the plan. The Court finds that the debtor did not attempt to conceal this information and that the other creditors have not been prejudiced by debtor’s inadvertence.”).
7 See, e.g., In re Rice, 72 B.R. 311 (D. Del. 1987) (Good-faith test failed when debtors’ plan permits the debtors to keep a new house worth $100,000 and two relatively new automobiles.); In re Reese, 281 B.R. 735, 740 (Bankr. M.D. Fla. 2002) (“The Court is troubled by the Debtor’s $2,300.00 house payment for a $330,000.00 house that was purchased . . . seven months prior to the filing of the petition and during the height of litigation with Triple Check. . . . [I]ts excessiveness evidences a lack of good faith.”); In re Larson, 245 B.R. 609 (Bankr. D. Minn. 2000) (That the debtor incurred a substantial unsecured business debt when his business was “clearly failing” and when the debtor “had no apparent intent or ability to repay” is substantial evidence of bad faith.); In re Sexton, 230 B.R. 346 (Bankr. E.D. Tenn. 1999) (That the debtor continued to draw upon a line of credit after borrowing money to pay off and close the credit is one factor bearing on good faith, but it is outweighed by the debtor’s sincerely intended effort at repayment before filing the Chapter 13 case.); In re Brigance, 219 B.R. 486 (Bankr. W.D. Tenn. 1998) (Plan was proposed in good faith notwithstanding that debtors incurred obligations to deferred presentment service providers within a few weeks of filing and had “rolled over” other debts to the eve of the Chapter 13 petitions.), aff’d on other grounds, 234 B.R. 401 (W.D. Tenn. 1999); In re Famisaran, 224 B.R. 886, 892 (Bankr. N.D. Ill. 1998) (Plan fails good-faith test based in part on evidence of “numerous automatic teller machine withdrawals at the machine located on the gambling boat.”); In re Mathenia, 220 B.R. 427, 433 (Bankr. W.D. Okla. 1998) (Lack of good faith where debtor and nonfiling spouse acquired $19,000 car 11 days before nonfiling spouse filed a Chapter 7 petition, and subsequent Chapter 13 petition by the debtor permits the couple to discharge a great deal of debt and acquire an asset. “[D]ebtor and his spouse have discharged over $46,000 in nonpriority unsecured obligations in their two Chapter 7 bankruptcy cases filed in 1993 and 1997. . . . At the same time, debtor and his spouse will have . . . a replacement vehicle valued at more than $19,000, which they clearly could not afford. . . . [T]hey will have paid less than $700 to their unsecured creditors. These are not the honest but unfortunate debtors which the Bankruptcy Code was designed to protect . . . . It is simply not right for debtors to voluntarily obligate themselves for the purchase of property which they clearly can not afford . . . and then expect to retain the property and force their unsecured creditors to pay for their folly.” ); In re Segura, 218 B.R. 166 (Bankr. N.D. Okla. 1998) (Creditor failed to prove lack of good faith in debtor’s Chapter 13 filing seven months after buying a car. Debtor made all contract payments prior to the petition, there was no evidence that debtor had any intention to file bankruptcy at the time of buying the car, and there was no evidence that the debtor filed solely to modify the car lender’s rights since car lender was treated as fully secured.); In re Sharon, 200 B.R. 181, 197 (Bankr. S.D. Ohio 1996) (Court rejects good-faith objection to 60-month, 24% plan that keeps $24,737.50 car. Applying factors listed in Metro Employees Credit Union v. Okoreeh-Baah (In re Okoreeh-Baah), 836 F.2d 1030 (6th Cir. 1988), debtor has a monthly income of $3,420 and monthly expenses of $2,420, and proposes to pay the $1,000 difference for the full 60 months. Statements and schedules were accurate, attorney’s fees were reasonable, and debtor established cause to extend the plan to 60 months. Debtor had Chapter 7 case in 1992, but intervening divorce and unanticipated repossession of car justified filing. Debtor made substantial down payment ($3,450) with respect to the objecting creditor’s car and “was not guilty of questionable prepetition misconduct in purchasing the Vehicle.”); In re Barnes, 191 B.R. 963, 965–66, 967 (Bankr. M.D. Ga. 1996) (Proximity of purchase of car to filing of Chapter 13 case indicates bad faith. Debtor filed 105 days after buying a used car and proposes to cram down car from $6,080.45 to $4,000. “If it can be shown that the recent purchase of the car by a debtor creates an unfair allocation of the debtor’s resources in favor of the purchase of a new car and away from the repayment of pre-existing unsecured creditors, such a plan may not be proposed in good faith. . . . [T]he treatment of a secured creditor in the case of a recently purchased automobile will be one factor among many which will be considered by the court at confirmation to determine whether the plan has been proposed in good faith.” Court denies confirmation but permits modification to pay the secured claim holder in full. Debtor “did not incur this debt with a view towards filing Chapter 13. Instead, Debtor experienced financial difficulties which had not been foreseeable at the time of the purchase of the vehicle.” Cramdown at debtor’s values would “create a virtual windfall for the Debtor” and would be “simply unfair and unsuitable to the equitable environment in which cases in this court must exist. . . . [I]t is unfair to allow Debtor to value the vehicle which is the subject of an installment sale contract within one hundred five days following delivery of that vehicle. If Debtor proposes to retain the vehicle, she should propose to pay the Federal claim in full.”); In re Mitchell, 191 B.R. 957, 960–61 (Bankr. M.D. Ga. 1995) (Not bad faith that the debtors purchased a van four and one-half months before petition. “The court refuses to adopt a per se rule or ‘bright-line’ test that a debtor’s purchase of collateral at some specified period of time before filing his Chapter 13 bankruptcy petition demonstrates lack of good faith. . . . [T]he proximity in time between a debtor’s purchase of the collateral and the filing of a Chapter 13 bankruptcy petition may be seen as evidence of the lack of good faith . . . . [T]he court finds that Debtors underwent an unanticipated change of economic circumstances which was not known to them at the time they purchased the van. . . . [S]he thought, at the time of the purchase of the van, that her unemployment benefits could be extended beyond February, 1995.”); In re Norwood, 178 B.R. 683, 690 (Bankr. E.D. Pa. 1995) (Court denies confirmation on good-faith grounds where debtor proposes no payment of a $60,000 claim for sexual assault and the plan would pay a home mortgage on property acquired after debtor committed the assault. “Debtor chose Chapter 13 as a means of absolving himself of liability from an otherwise nondischargeable debt without the need of making any payment thereon while still retaining the benefit for himself of the property he acquired after entry of the Judgment.”); In re Webster, 165 B.R. 173, 175–76 (Bankr. E.D. Va. 1994) (Confirmation is denied on good-faith and disposable-income-test grounds where debtor’s residence was destroyed before the filing of the Chapter 13 case, but the debtor proposed to pay $20,000 to a creditor with a mortgage on the remaining real property and nothing to unsecured creditors. “Here debtor proposes to pay nothing to her unsecured creditors; instead she wants to pay for a $20,000 asset which at this time may be considered investment property. The plan is thus discriminatory of debtor’s creditors and cannot be considered as filed in good faith.”); In re Cordes, 147 B.R. 498 (Bankr. D. Minn. 1992) (Confirmation is denied on good-faith grounds because plan will allow the debtor to build up equity in an expensive, nonexempt luxury recreational boat while paying less than half of general unsecured claims.); In re Henricksen, 131 B.R. 467 (Bankr. N.D. Okla. 1991) (Substantial cash was in an IRA.); In re Dotson, 124 B.R. 836 (Bankr. N.D. Okla. 1991) (60% of debtor’s payments would go to pay for a luxury motor vehicle, and debtor took an expensive Caribbean cruise on the eve of bankruptcy.); In re Lindsey, 122 B.R. 157 (Bankr. M.D. Fla. 1991) (Three-year plan would be used to acquire equity in an investment property. Acquiring luxury goods through a Chapter 13 plan is properly measured against the good-faith standard in § 1325(a)(3).); In re Jones, 119 B.R. 996 (Bankr. N.D. Ind. 1990) ($22,000 Cadillac was acquired on the eve of bankruptcy.); In re Selden, 116 B.R. 232 (Bankr. D. Or.), aff’d, 121 B.R. 59 (D. Or. 1990) (Purchase of a $790 stereo on the eve of bankruptcy is not bad faith when the stereo is the primary source of entertainment for debtor’s children.); In re Chrzanowski, 70 B.R. 447 (Bankr. D. Del. 1987) (Bad faith was indicated when debtor borrowed $14,000 for a new car after filing and without court approval.); In re Rogers, 65 B.R. 1018 (Bankr. E.D. Mich. 1986) (Bad faith is demonstrated when debtor’s four-year plan gives the illusion that unsecured claim holders will be paid, when in fact the plan permits the debtor to acquire a $17,000 Corvette.); In re Brown, 56 B.R. 293 (Bankr. N.D. Ill. 1985) (Recent debt for new automobile indicates lack of genuine intent to pay.); In re Myers, 52 B.R. 248 (Bankr. M.D. Fla. 1985) (Debtors filed Chapter 13 immediately after borrowing $2,200 and failed to commit the recently borrowed funds to funding the plan.).
8 See § 102.1 [ Surrender or Sale of Collateral ] § 74.5 Surrender or Sale of Collateral before BAPCPA.
10 In re Carsrud, 161 B.R. 246, 247 (Bankr. D.S.D. 1993) (Court denies confirmation on good-faith ground of second Chapter 13 case “targeted” to discharge a civil judgment against the debtor for sexual assault, including rape, of his natural sister. First Chapter 13 case was dismissed because the debtor’s unsecured debts exceeded $100,000 limitation in § 109(e) [prior to amendment in 1994]. After dismissal of the first case, the debtor negotiated, settled, and paid approximately $2,000 to creditors other than his sister to reduce his total unsecured debts below the $100,000 debt limitation. The debtor immediately filed a second petition proposing to pay 2.4% of his sister’s judgment. The debtor miscalculated the amount of his sister’s judgment and made no meaningful effort to pay the judgment before or between the bankruptcy filings. “Motivation and sincerity, coupled with the nature of this debt and whether it is dischargeable in Chapter 7, are the most centrally implicated factors in this case.”).
11 See In re Hendricks, 250 B.R. 415 (Bankr. M.D. Fla. 2000) (After entry of a large judgment in California, the debtor “virtually fled to Florida, a state with a liberal tradition of homestead exemptions,” and converted all of her available assets into a homestead. Within a few months, the debtor filed a Chapter 7 case that was converted to Chapter 13 to avoid discharge and dischargeability litigation. Plan proposes 0% to unsecured claim holders. Plan is not proposed in good faith.).