Exemption Planning in Bankruptcy -

     Exemption planning is the practice of a debtor converting nonexempt assets into exempt form, filing bankruptcy and then claiming the property as exempt. This is expressly allowed, according to the Congressional legislative history behind the Bankruptcy Act of 1978, which said: ",,,, the debtor will be permitted to convert nonexempt property to exempt property before filing a bankruptcy petition. The practice is not fraudulent as to creditors, and permits the Debtor to make full use of the exemptions to which he is entitled under the law."

Pre-bankruptcy Exemption Planning

     Despite this clear legislative intent, trustees and creditors over the years have challenged this type of"pre-bankruptcy exemption planning" as being fraudulent. They have sought, among other things, to: object to the exemption; object to the debtor's discharge, claiming that the conversion of assets into exempt form constituted a transfer of property with the intent to hinder, delay and defraud creditors under Bankruptcy Code Section 727(a)(2); surcharge the exemptions and make them liable for payment of the trustee's administrative expenses, especially where the transfer was not disclosed; and seeking criminal prosecution on the grounds that the planning constituted a fraud on creditors.

Different Conclusions in the Courts

     Courts have come to a variety of different conclusions on these issues. Some allow it as perfectly acceptable, contemplated by the bankruptcy law, and being akin to taxpayers organizing their personal and business affairs to minimize payment of income taxes. This is believed to be the better view. Other courts, perhaps ignoring the clear congressional intent, have disallowed such planning efforts and punished the debtor. Finally, in what is probably the most common result: courts allow such planning, as long as the debtor does not do too good of a job at it. If the transfer involves, say, $10,000 or less, then it will probably pass muster. If the conversion extends into the hundreds of thousands of dollars, on the other hand, the court will be more inclined to find a reason to disallow the exemption or otherwise punish the debtor.

Uncertainty and the Debtor's Lawyer

     The uncertainty in this area of asset protection makes it a very difficult job for the debtor's lawyer. Even after decades of case law on the subject, no "bright-line" test has emerged as to what is acceptable and what is not. Much will often depend on such variables as the location of the court, the proclivities of the particular panel trustee assigned to the case, the aggressiveness of the local U.S. Trustee, and the personal feelings of the bankruptcy judge assigned to the case.

     The attorney needs to be careful, because he faces potential personal civil and criminal liability if he is involved in planning which is subsequently found to be improper. Practitioners should review the facts of each case carefully. Then, they should harken back to the old saying: "Hogs get slaughtered, little piggies get to come back for more".

Strategies for the Debtor

Automatic Stay, - Automatically stops most creditor action against the debtor "Lien-stripping" - Generally available in Chapters 11 and 13, "Use of "Avoiding Powers" - May let the debtor sue creditors and "undo" certain harmful transactions "Race to the Courthouse" - A bankruptcy filing allows assets to be sold by the debtor or trustee, over a reasonable period of time

Written by Henry Rendler