In Chapter 7 and Chapter 13 bankruptcies, there are several common issues that frequently arise.  In this context, the word “issues” translates to “opportunities for the case Trustee to recover money/assets for the bankruptcy estate.”  Ideally, most bankruptcy issues can be spotted prior to filing the bankruptcy and a debtor attorney can provide appropriate counsel to minimize or avoid problems occurring after the case has been filed.

Non-Exempt Assets

A debtor’s property is either exempt (i.e. protected), excluded from the estate (i.e. not part of bankruptcy estate), or non-exempt (i.e. unprotected).  The bankruptcy estate is broadly defined under § 541(a) and is enhanced with a Trustee’s unique ability to avoid liens, recover payments, and undo certain transfers.

The Trustee has the option to pursue property that is neither exempt nor excluded.  If the value of the non-exempt property reaches a particular threshold, for example $800, a Trustee will then decide to take the property and use it to help repay scheduled creditors.  Each Trustee has a minimum threshold of how much money justifies administering an “asset” case.  The most common non-exempt assets include too much equity in a vehicle, receiving a large tax refund, as well as, whole life insurance policies and annuities that fail to meet the exemption requirements under Arizona’s statutes.

Lien Avoidance

Under the bankruptcy code, the Trustee has unique “strong arm” powers that include the ability to avoid certain liens and transfers.  Specifically, § 544 creates a Trustee lien against all property in the bankruptcy estate, which thereby elevates the Trustee to a “secured” lien creditor.  Thereafter, the Trustee can use the U.C.C. § 9-317’s “first-in-time” lien against any liens filed after the date of the filed bankruptcy petition or against any liens that were unperfected (meaning incorrectly filed).

Lien avoidance is not unusual with respect to unperfected liens against vehicles.   In Arizona, a motor vehicle lien is not perfected until the date the application for title reflecting the lien is endorsed with a stamped date of receipt by the Department of Motor Vehicles (North v. Desert Hills Creditor, 310 B.R.152, 160 (Bankr. Ariz. 2004).  Arizona statutes further provide that for a lien to be valid it must comply with the requirements of the law, which are elaborated upon under Arizona Revised Statues.  A creditor should prefect their interest in a motor vehicle within 20 days of the date the debtor took possession of the vehicle.

In the event the lien is not properly perfected, the Trustee can avoid the lien.  The debtor must then secure new financing, such as thru a redemption program, or must otherwise pay the Trustee for the value of the vehicle, minus any applicable exempt equity that existed above the voided lien amount. Otherwise, the vehicle will be taken by the Trustee and sold to pay unsecured creditors.

Preferential Payment

Under §547(b), a Trustee may avoid any transfer of interest of the debtor’s property if 1) the transfer was for the benefit of a creditor for an antecedent debt, 2) the debtor was insolvent at the time of the transfer, 3) the transfer was made within 90 days before filing the petition (or one year if the transfer was to an “insider”, i.e. family member or business partner), and 4) it enables a creditor to receive more than they would have received through the Chapter 7 claims process.

Simplified, if a creditor gets “preferential” treatment and the transaction fits within the provision of § 547(b), the Trustee can seek to recover the money against the recipient thereof.  The Trustee has the burden of proving the ability of avoiding of a transfer.  In practice, a debtor’s attorney reviews these issues while preparing the petition and they should be revealed and discussed prior to filing the case.

Fraudulent Transfers

The case Trustee also has the ability to set aside any transactions that are deemed “fraudulent transfer” under Federal or State law (See Code § 548, A.R.S. § 44-1001, et seq.).  Under the bankruptcy code, a bankruptcy Trustee may void any transfer within the last two years preceding the date of the filing of the petition if 1) the debtor made the transfer with the actual intent to hinder, delay, or defraud any entity,  2) the debtor made the transfer and received less than a reasonably equivalent value in exchange for such transfer, or 3) the debtor was or became insolvent on the date the transfer incurred and as a result of the transfer  (See 11 U.S.C. § 548).

Arizona law expands the “fraudulent transfer” doctrine to include 18th Century badges of fraud principles that include general concepts such as was the transfer to an insider, did the debtor retain possession or control of the property after making the transfer, was the transfer or obligation disclosed or concealed, was the debtor threatened to be sued or sued just before the transfer was made, etc.  Basically, if the transfer looks suspicious and if there is a lack of reciprocated value, there may be a fraudulent transfer issue.  A common example is a gift or transfer of property to a family member just prior to filing bankruptcy or just after being sued.

Defenses

The general defense to a fraudulent transfer or preferential payment is that the transfer or transaction falls within the “contemporaneous exchange for value” exception (See §547(c)(1)), was made in the “ordinary course of business” (See §547(c)(2)),   or that the transaction is a “purchase-money security interest” (See §547(c)(3) & U.C.C. §§ 9-317(e), 9-324(a)).

Under Arizona law, there is a general defense that protects the recipient of an alleged fraudulent transfer if the person undertook the transaction in good faith and for a reasonable equivalent value (See A.R.S. § 44-1008(A)).  An attorney needs to carefully review the application of each exception in the event that a Trustee raises a fraudulent transfer or preference issue.