How Planning Ahead Can Protect Your Cash and Bank Accounts in Bankruptcy
How bankruptcy will affect your cash or bank account deposits depends on whether the money is protected by a bankruptcy exemption. This guide will give you advice on pre-bankruptcy planning in order to help you protect money that will not be exempted by a bankruptcy exemption.
Is Your Cash or Bank Account Deposit Protected by a Bankruptcy Exemption?
In bankruptcy, certain limits determine whether your property is "exempt," which means it is protected from seizure, forfeiture, or liquidation by the bankruptcy trustee. Although these limits are the same in Chapter 7 and 13, the exact figures vary from state to state. While some states allow using federal exemption limits, others mandate using only their state-specific exemption figures.
In Chapter 7 and 13, the trustee cannot take exempt property. However, in Chapter 7, any cash or bank account over the exemption limit is considered "non-exempt assets" and will be seized by the bankruptcy trustee. In Chapter 13, non-exempt funds will not be seized but the debtor will have to pay the non-exempt portion back during the life of the bankruptcy plan.
If part of your cash or bank account is not covered by an exemption, you may still be able to protect some or all of these funds by some careful pre-bankruptcy planning.
Pre-Bankruptcy Planning to Convert Non-Exempt Funds into Exempt Assets
Pre-bankruptcy planning, also known as asset conversion, is the legal method of reorganizing assets in order to protect as much property as possible from creditors. In the context of cash and bank accounts, this means using funds over the exemption amount to purchase or invest in exempt assets. However, debtors must keep in mind that there is a thin line between acting in good faith when legally converting nonexempt property into exempt property according to the U.S. Bankruptcy Code and acting in bad faith when attempting to hinder, delay, or defraud creditors. Also, while the majority of courts recognize that debtors are allowed to convert nonexempt property into exempt property, a minority of courts have denounced it as fraud. Although you must tread carefully, pre-bankruptcy planning is a legitimate and legal process as long as certain general principles are followed. When in doubt, consult an experienced bankruptcy attorney in your area who is familiar with the local rules.
Forms of Allowable Pre-Bankruptcy Planning
Most courts recognize that, absent fraudulent intent on the part of the debtor, asset conversion is allowed in order to make full use of statutory exemptions, even if done on the eve of bankruptcy. Thus, prior to filing for bankruptcy, courts will generally allow you to use non-exempt portions of your cash and bank account funds in order:
- Pay your bankruptcy attorney.
- Pay down your mortgage in those states with significantly large homestead exemptions.
- Make an annual contribution to your retirement account.
- Purchase exempt personal property, such as a car, household goods, furniture, clothes, or other essential items. Remember, the exact exemption amounts for each of these items varies from state to state.
- Purchase a life insurance policy.
- Pay down your non-dischargeable debts such as taxes, student loans, alimony, and/or child support.
Forms of Non-Allowable Pre-Bankruptcy Planning
Actions that indicate evidence of intent to defraud or hinder the bankruptcy process may result in penalties. In determining whether you intended to defraud creditors, courts will consider whether you: misrepresented asset values, received inadequate value for funds spent, involved family or other close relations in asset purchases, and radical changes in lifestyle. When considering what to do with your non-exempt cash or bank account funds, remember the following:
- Do not give money away, or hide money, or simply transfer it to another's name.
- Pay fair market value for any purchases and engage only in legitimate transactions.
- Do not repay debts to relatives or friends prior to filing because it would constitute a "preferential transfer" and the bankruptcy trustee can recover those funds.
- You will have to disclose all asset transfers "outside the ordinary course of business" made within 90 days of filing or within 1 year of filing if made to a friend or relative.
Additional Measures to Protect Cash and Bank Account funds: Avoiding Set-Offs and Freezes
If you owe your bank or credit union any money at the time of filing for bankruptcy (such as past due fees) or if your bank or credit union has extended credit to you (such as a loan, mortgage, or credit card), that institution has the right to “set off" the debts owed to it against any bank account funds you may have with them. Although banks rarely exercise this right, it is better to be safe. The best way to avoid a set-off is to take out the funds of any account held with a bank or credit union to which you owe a debt.
Another issue with bank accounts arises when banks “freeze" your accounts once you file for bankruptcy. This is the policy of some banks, primarily Wells Fargo and Union Bank, to preserve your funds until the bankruptcy trustee decides what to do with them. Although a judge will eventually order “unfreezing" the accounts, it could take several weeks. To be safe, take out any funds in Wells Fargo or Union Bank accounts or transfer the funds to a different bank.