When Can the Trustee Avoid the Transfer of Property in a Divorce Settlement?

Even if a debtor declares bankruptcy, creditors have rights to collect on debts that are owed to them. Bankruptcy law includes certain protections for creditors’ rights. One such rule allows a bankruptcy trustee to void fraudulent transfers when the debtor:

made such transfer or incurred such obligation with actual intent to hinder, delay, or defraud any entity to which the debtor was or became, on or after the date that such transfer was made or such obligation was incurred, indebted.

11 U.S.C.A. § 548(a)(1)(A) The bankruptcy trustee may cancel a transfer that you’ve made if the purpose of that transfer was to shortchange a creditor.

In re Hill

In re Hill, 342 BR 183 (D. N. J. 2006), a case decided here in New Jersey, provides a nice example. Here are the facts. Immediately prior to her bankruptcy case, Phyllis finalized a divorce with her husband, Daniel. As her divorce was proceeding, Phyllis lost a lawsuit to Synergy, who had recently purchased Phyllis’ mortgage company. The court judged that Phyllis owed Synergy $160,000. Phyllis and Daniel struggled through their divorce proceedings. Both made several proposals for how to divide their assets and settle the divorce, but each attempt failed. Daniel’s pension, which had accumulated to over $500,000, was the most contentious asset. In their early settlement attempts, Phyllis demanded half of Daniel’s pension. The couple consulted settlement negotiation experts, who testified that Phyllis was likely to be awarded the 50% she sought if the matter were decided by a judge. Phyllis also sought to avoid paying alimony and to keep their marital home for herself. In a strange turn from her high-flying original demands, Phyllis agreed to accept a mere 33% of Daniel’s pension, make a lump sum alimony payment of $150,000, and even let Daniel keep their marital home.

The Trustee Gets Wise to Phyllis’ Motive

Curious about Phyllis’ sudden and generous change of heart, her Chapter 7 trustee speculated that Phyllis’ transfer of assets in the divorce settlement might have been designed to prevent her creditor, Synergy, from taking those assets in liquidation. So, the trustee sought to avoid the transfer under 11 U.S.C.A. § 548(a)(1)(A). Phyllis owed a substantial amount of money to Synergy, so she was going to lose most of these assets anyway. Apparently she would rather fork over the dough to her ex-husband than to Synergy.

Scenarios Where a Divorce Settlement May be Fraudulent

The court explained two common scenarios in which a divorce settlement may be fraudulent. First, the divorce itself may be a sham. Under the sham theory, the husband and wife would not actually desire a divorce, but would instead agree to one in order to divide their assets, and shield as many of them as possible from a creditor. Under the second theory, the divorce itself would be legitimate, but nonetheless a spouse would decide to give as much as possible to his or her former spouse rather than a creditor. Daniel and Phyllis had been having marital problems for quite some time, and had even separated on multiple prior occasions. When she filed for bankruptcy, Phyllis was involved in another relationship. The divorce was no sham, but the final agreement would have prevented Synergy from collecting its sizeable judgment. The court recognized that the divorce settlement was not only heavily favorable to Daniel, but was also far more generous than Phyllis’ previous settlement offers. Phyllis agreed to the settlement only a couple of months after Synergy won its judgment against her. Then she concealed the divorce settlement from Synergy. Because of the suspicious timing, Phyllis’s dishonest treatment of Synergy, and the obvious inequity of the divorce settlement, the court agreed with the trustee that the transfer was fraudulent. The only way the transfer could go through was if Daniel was found to be a good faith transferee (recipient of transferred property). A good faith transferee may keep the transferred property if he traded something of equivalent value for it. Unfortunately, the court determined that Daniel knew or should have known that Phyllis was up to something. They were not on amiable terms and she had previously offered him much less; he gave her nothing more in the final settlement than he hadn’t offered before.

Trustee  Voids the Divorce Settlement

The trustee was able to void the unfair portion of the transfer because of Phyllis’s dishonesty and Daniel’s tacit complicity. The court determined, with the help of Family Court experts, an equitable distribution of Phyllis’s and Daniel’s assets. That calculation showed that Phyllis ceded about $215,000 more to Daniel than was fair. Daniel had to return the $215,000 to Phyllis’s estate to restore them both to the position in which they would have been after a fair settlement. With the extra $215,000 in her pocket, Phyllis was more than able to pay Synergy its judgment lien against her. Phyllis incurred that judgment as a result of her fraudulent dealings with Synergy, and judgment liens for fraud are nondischargeable in bankruptcy. Synergy received what Phyllis owed it and Phyllis continued on in her bankruptcy proceedings. She ended up in court several more times over the course of her bankruptcy attempting to shield or hide other assets.

Practical Considerations

In bankruptcy, debtors frequently try to get creative in an effort to avoid paying a creditor. The court has seen all of the tricks before – they’ll know what you’re doing and they’ll stop you. Be honest in bankruptcy and you can start afresh. Be deceitful and the court has the power to force you to an equitable result. If you are considering bankruptcy, you should consult with an experienced attorney who can ensure your finances are handled efficiently and legally.