Providing updates and comments on Florida estate planning and creditor protection developments and insight for lawyers, CPAs, and other planning professionals.

 Welcome to our first edition of The Thursday Report!

Each week we will provide a recent case or other development in summary form with analysis and ideas associated therewith. Please send us your ideas for future topics!

These reports will also be posted to our website at gassmanlaw.com.

We welcome all questions, comments and suggestions and thank our law clerks, Kacie Hohnadell, Allison Wallrapp, and Andrew Spence, for their efforts and dedication in assisting us with research and analysis.

Cooking Up a Fraudulent Transfer Defense

Harry Caray, one of the baseball’s best announcers, always had a way to make the game more fun. When a player knocked the ball out of the park, he would yell with enthusiasm, “it might be, it could be, it is! A home run!” The same could be said for the court’s decision in the case of In re Cook, 460 B.R. 911 (Bankr. N.D. Fla. Dec. 7, 2011), in which the debtors scored the legal equivalent of a home run.

In this case, the court found that a $175,000 investment of non-exempt funds by husband and wife into a new homestead was not a fraudulent transfer under Florida or federal bankruptcy law, despite the fact that the home was purchased only days before the bank filed a collection action and less than five months before the couple filed for bankruptcy.

In determining that the investment was not a fraudulent transfer, Judge Killian of the United States Bankruptcy Court for the Northen District of Florida stated the following on page 914: “The Debtors’ explanation that the purchase of the homestead using the non-exempt tax refund was to ensure that they had a permanent place to live is credible and realistic” and “receiving the tax refund finally give the Debtors the opportunity to procure a stable and permanent residence.”

In this case, the Cooks obtained a $3 million dollar loan to begin a car dealership business. Once the economic bubble burst in 2008, the car dealership suffered substantial losses, causing the Cooks to default on the loan and file for bankruptcy. The Cooks sold their home, once valued at $5 million, for $2.3 million to pay the remainder of the mortgage and to pay down part of the loan. The couple was then forced to move into a mobile home after being unable to afford a down payment or receive credit to purchase a new home.

In 2010, the Cooks received a tax refund of $184,769, which they used to make a down payment on a waterfront home on January 3, 2011, with a purchase price of $800,000.  The Cooks made a $155,000 cash down payment, and the seller gave them a mortgage for the remaining amount owed. In addition to the down payment, the Cooks spent $20,000 making improvements to the home.

In mid-January 2011, the bank initiated a lawsuit against the Cooks as a result of their default on the loan, and a judgment was entered against the couple in March 2011. Unable to pay the judgment, the Cooks filed for bankruptcy on May 23, 2011 and claimed the property as homestead, even though it was acquired less than five months before filing the petition (the Cooks closed on the property January 3, 2011 and filed for bankruptcy on May 23, 2011).

This was either a gutsy or foolish move on the part of the Cooks. If the court had determined that the Cooks committed a fraudulent transfer by using the tax refund to purchase the home, not only would the Cooks have lost their home, but they also would have been eternally unable to discharge the judgment owed to the bank.

In the bankruptcy hearing, the creditor objected to the homestead exemption under Section 522(o)(4) of the Bankruptcy Code, which provides that “a debtor’s homestead exemption shall be reduced to the extent that the debtor, with an intent to hinder, delay or defraud a creditor, converted non-exempt assets into exempt assets within ten years of the bankruptcy filing.”[1] However, the court found that the Cooks did not convert the non-exempt asset (tax refund) into an exempt asset (homestead property) with fraudulent intent, noting that it was reasonable for the Cooks to buy a home to ensure that they had a permanent place to live. Further, the court noted, “[w]hile it may seem unreasonable to purchase an $800,000 waterfront property after living in a mobile home, the Debtors actually went from living in a $5 million home to a home worth substantially less.”[2]

The court also determined that the couple’s equity in the home did not exceed the cap under Bankruptcy Code Section 522(p)(1), which applied in 2011 and caps the homestead exemption at $146,450 for property acquired within the 1,215 days preceding the filing of a bankruptcy; however, because the cap applies separately to each individual debtor, the couple’s cap was increased to $292,900, which allowed the entire amount of equity in the home to remain exempt.

The Trick

Debtors have the right to conduct their affairs as they see fit, and not every transfer or transaction is intended for the purpose of avoiding creditors.  Thus, if there is a good reason for the transaction, separate and apart from incidental creditor protection benefits, smart planning may allow a debtor to enter into a transaction without facing the harsh consequences of a fraudulent transfer, but this is never without risk.

Similar cases:

In the case of In re Agnew,[3] the court found that a home acquired just five days before filing for bankruptcy did not constitute a fraudulent transfer under federal Bankruptcy law and determined that the ten year look-back provision under Bankruptcy Code Section 522(o) did not apply.

In this case, a farmer owned an undivided one‑fifth (1/5) interest in farmland as well as some farming equipment.  His mother, in trust, owned the remaining four‑fifths (4/5) undivided interest in the land.  The farmer leased the 4/5 parcel from his mother for farming purposes and to live on.

Prior to filing bankruptcy (the farmer was indebted by over $130,000), he transferred his 1/5 interest in the land and his farm equipment to his mother’s trust in exchange for the parcel of land on which he lived.

Years prior to the transfer, the farmer and his mother had discussed making the transfer to ensure he would not be evicted from the home by his siblings on his mother’s death, but the farmer procrastinated making this transfer until just before filing for bankruptcy. However, just prior to making the transfer, he received economic counseling advising from an economist working in a creditor counseling program, who advised him to make this transfer.

The judge found that the values were reasonable and that the transfer should not be defeated by Bankruptcy Code Section 522(o)(4), which authorizes the reduction of the amount claimed by a bankruptcy debtor in the amount of any such property that was disposed of in a ten-year period prior to the filing of the bankruptcy petition, if the transfer was made with the intent to hinder, delay, or defraud creditors.  Thankfully for the debtor, the court found that there was no intent to defraud creditors, since the farmer’s intent was to ensure he was not evicted from his home when his mother died and the anticipated bankruptcy filing was not the reason for the transaction.

The Trap

If you commit a fraudulent transfer within one year of filing a Chapter 7 bankruptcy, you lose any and all rights to discharge your existing debt, which can be an extremely devastating consequence for a client who is unable to pay his or her debt. Therefore, you should be very, very careful with respect to any transfer that could be considered “fraudulent” under Florida Statutes, Section 222.29 and US Bankruptcy Code Section 727.

We hope that this weekly report reaches you well and eager to learn about the innovations happening in your professions. Please do not hesitate to contact us with any comments, questions or future topics!

As stated by the Honorable Judge Learned Hand, “[a]nyone may arrange his affairs so that his taxes shall be as low as possible; he is not bound to choose that pattern which best pays the treasury. There is not even a patriotic duty to increase one’s taxes. Over and over again the Courts have said that there is nothing sinister in so arranging affairs as to keep taxes as low as possible. Everyone does it, rich and poor alike and all do right, for nobody owes any public duty to pay more than the law demands.”

Thank you to our law clerk who assisted us in preparing this report:

Kacie Hohnadell is a third-year law student at  Stetson University College of Law and is considering pursuing an LL.M. in taxation upon graduation. Kacie is also the Executive Editor of Stetson Law Review and is actively involved in Stetson’s chapter of the Student Animal Legal Defense Fund. In 2010, she received her B.A. from the University of Central Florida in Advertising and Public Relations with a minor in Marketing and moved to St. Petersburg shortly after graduation to pursue her Juris Doctor.

For details about each event, please visit us online at gassmanlaw.com

[1] 11 U.S.C. at § 522(o)(4)

[2] In re Cook, 460 B.R. 911, 914 (Bankr. N.D. Fla. Dec. 7, 2011)

[3] 355 B.R. 276 (Bankr. D. Kan.2006).