Why Does Gift or Loan Matter for Bankruptcy?

When people give each other money, we can consider it a gift or a loan. And if you are considering filing for bankruptcy now or in the near future, you must take any loans or gifts into consideration. Why? Because when the gift was given, and whether it properly qualifies as a gift or a loan, can influence whether or not you get to keep the money or if that money would have to be used to pay off creditors.

The Trustee and Their Job

If you are filing either a Chapter 7 or Chapter 13 bankruptcy, a trustee will be assigned to your case. A trustee takes temporary control over your finances. They gather your income information as well as information on your debts and assets. In a Chapter 7 bankruptcy, the trustee will then liquidate all non-exempt assets and distribute the proceeds among your creditors. In Chapter 13 bankruptcy, the trustee will put together a 3 to 5 year payment plan that allows you enough money to live on while paying as much money as possible to your creditors.

Gifts and Bankruptcy

Before moving on, let’s look at what a gift technically is. A gift is a one-sided exchange of an asset from one person to another without a reciprocal expectation. A gift can come in the form of cash or some other type of tangible property. So if anyone has given you anything of value, but there is no promissory note or note of obligation to repay the value of the said item, then it is considered a gift for the purposes of bankruptcy.

How gifts are handled depends on whether you filed Chapter 7 or Chapter 13 bankruptcy. The general rule is that any gift you are given before filing for bankruptcy is considered an asset and, therefore, is subject to liquidation by the trustee in order to pay debtors. So in Chapter 7, it’s pretty simple: If you got the gift before filing, then the gift is fair game. It will be liquidated and used to pay off your debt. However, if the gift came after filing bankruptcy, then it is yours to keep.

But with Chapter 13, it is a bit trickier. Again, if the gift came prior to filing, then it will be included in the amount of money you have available to pay off creditors within your payment plan. However, after filing, it can take your trustee several months to arrive at a payment plan that the judge will sign off on. If you receive a gift during the pendency of your bankruptcy, the trustee may seek to include that money in the amount available to pay off creditors and your payments may increase accordingly. However, if the gift comes after everything is signed off on, then you will be able to keep it.

Loans and Bankruptcy

Loans are essentially anything given to you where you signed a promissory note or contract where a reciprocal obligation is required. This note or contract can exist between you and a business entity or you and a friend or relative. If the contract was entered into prior to your filing for bankruptcy, then it gets consideration during bankruptcy proceedings. The lender becomes a creditor just like any other creditor and is entitled to be paid back as much as possible according to your assets.

However, if there is no written contract, there is no loan. So even if you and Uncle John verbally agreed that you would pay him back the $4,000 he gave you to buy your car – but there is no written document that was executed as part of the agreement – then the loan is considered a gift, becomes part of your assets, and is subject to liquidation as per the rule on gifts.

Fraudulent Transfers and Ramifications

Gifts and loans are closely scrutinized by trustees because they are looking for fraudulent transfers. Depending on the bankruptcy rules of your state, the trustee can look back two years or more at any transfers of assets in order to determine if those transfers were fraudulent. A fraudulent transfer is defined as a transfer or sale of an asset in order to avoid that asset being liquidated for the purposes of paying creditors. There are two types of fraud:

  • Actual Fraud – This is where there is a clear intent to defraud or hinder your creditors from receiving payment from the liquidation of a certain asset. For example, if you put your car in someone else’s name or gave a large cash gift to someone before filing for bankruptcy, with the purpose of hiding those assets from your creditors, that is considered actual fraud.
  • Constructive Fraud – This is a situation that is somewhat less obvious than actual fraud, and therefore requires a bit more scrutiny to uncover. For example, the trustee finds that you sold your home to your Uncle Jack for $100. Unless your home is a straw hut, chances are that the sale doesn’t pass the smell test. Any sales of assets during the lookback period must be for fair market value in order to not be considered constructively fraudulent.

Options When Fraud Is Discovered

A bankruptcy trustee has a lot of power and many options when they suspect fraud in the transfer of assets prior to filing bankruptcy. One option is to actually “unwind” the transfer by suing to void the transfer as if it never existed. The trustee can then take possession of the asset, liquidate it, and properly distribute it to your creditors. However, if they find the fraud is of a particularly egregious nature, the trustee may ask the court to dismiss your bankruptcy filing entirely.

Another tool at the trustee’s disposal is what is known as a “clawback.” This provision allows a trustee to determine if you improperly transferred property prior to filing bankruptcy, and allows the trustee to attempt to get the property back so it can be included in your estate assets. For instance, if you repaid Aunt Alice the $10,000 you owed her before filing bankruptcy, the trustee can attempt to get that money back.


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