8th Circuit Holds Exempt Property Subject to Fraudulent Transfer Laws

November 1, 2011

By: David M. Serafin

In Sullivan v. Welsh et al., the 8th Circuit Court of Appeals reversed a Minnesota Bankruptcy Court decision which had ruled that a bankruptcy debtor could not fraudulently transfer exempt property. In 1994, debtor and her husband at the time signed a subsequently recorded contract to purchase a home from debtor’s parents. Debtor and her husband eventually defaulted on the house payments. Husband then filed for divorce. After the creditor parents of debtor served a notice of cancellation upon debtor and her soon-to-be ex-husband, the latter borrowers agreed to quit claim the property back to the former, and both quit claims deeds were executed about a year prior to debtor filing chapter 7 bankruptcy.

The Minnesota court held that transfers of property deemed exempt under state law cannot be avoided by a bankruptcy trustee because exempt property cannot be fraudulently transferred under Section 548(a)(1) of the Bankruptcy Code. In reversing this holding, the 8th Circuit found that, although the nature of the property interest in determined by state law, Section 548 controls the issue of whether a transfer of property is fraudulent.

The 8th Circuit rejected the “no harm, no foul” approach taken by other bankruptcy courts in finding that a property exemption is personal to a bankruptcy debtor and cannot be used by the transferee (the creditor parents here). The court also reasoned that a debtor should not be able to claim an exemption for property she voluntarily transferred (thereby implying that an exemption may be claimed for property – such as garnished wages, levied bank account funds, or otherwise property seized by a creditor - involuntarily transferred). The 8th Circuit remanded back to the bankruptcy court the issues of whether debtor received less than fair and adequate consideration, and whether she was insolvent at the time of the transfer.

As a Littleton personal bankruptcy lawyer, I believe that the bankruptcy court should strongly consider the facts that debtor was following a court order and not attempting to truly defraud anybody. Negating the transfer would further benefit the unsecured creditors to the detriment of the contract debtor was trying to comply with.

Especially considering the after effects of the Sullivan decision, which now provides a bankruptcy trustee the power to avoid transfers of exempt and non-exempt property for up to four years prior to filing in Colorado Bankruptcy Court (two years under the Bankruptcy Code but four years under the Uniform Fraudulent Transfers Act), it is critical that you explain to me any plan for transferring any property beforehand.

We will discuss issues such as the estimated property value, date of planned transfer and debtor’s relationship to the transferee. Similarly, I will prepare you for how to address disposition of a previously transferred property in chapter 7 or chapter 13, particularly if a bankruptcy cannot be delayed. In chapter 7, if the trustee is not able to compel turnover of the property from the recipient, the trustee can force the debtor the value of the property back to the bankruptcy estate. (An unanswered question is whether the trustee can compel turnover of solely the non-exempt portion of the value or the entire value.) In chapter 13, the debtor can pay back the property value through a three to five year repayment plan.