How Chapter 7 Works
Chapter 7 is a liquidation bankruptcy. This means that when you file, the trustee takes possession of most of your assets and sells the property to raise money to pay your debts. He won't take all of your property, though. You're allowed certain exemptions under both federal and state laws. For example, you might use exemptions to protect the equity in your home and to protect your household furnishings. The trustee cannot liquidate exempt property, so you can keep it. Your creditors may not receive payment of all you owe in a Chapter 7 proceeding, and if you have no non-exempt assets the trustee can sell, your creditors won't receive anything at all. After payments to your creditors, or no payments if your trustee determines that there are no assets in the bankruptcy, you'll receive a discharge, which means you're no longer legally responsible for paying those debts.
Federal law prohibits you from selling or giving away assets within two years of filing for Chapter 7 bankruptcy. An exception exists if you sell something for its fair market value – this is not a fraudulent conveyance. For example, your great aunt might have left you a cherished piece of artwork that's worth $7,000. If you sell it for $7,000, this doesn't present a problem. If you sell it for $5,000, however, you've fraudulently conveyed it if you were insolvent at the time you made the sale – meaning that you had more debts than assets. If you then transfer ownership to your best friend thinking that you can get take it back later when your bankruptcy is over, this is fraud. The laws in some states provide for longer time periods than the federal two-year rule. For example, in California, it's seven years. If your state's time period is longer than two years, your trustee must abide by the state law, rather than the federal bankruptcy law.
If you've committed a fraudulent transfer, either intentionally or unintentionally, the trustee is obligated by law to get the property back and return it to your bankruptcy estate for purposes of liquidation. You can no longer use an exemption to protect it from sale if it would have been covered by one. If you fraudulently sold the asset, the buyer becomes a creditor in the proceedings and is entitled to the return of his purchase money. The trustee can file a motion to dismiss your bankruptcy case if he decides that your action was a deliberate attempt to defraud the court and your creditors. In this case, you will still owe all your creditors, and the conveyance may become a criminal offense, punishable by fines and jail time.
If you think there's any possibility that you might file for Chapter 7 in the years ahead, consult with an attorney before you sell or give away any property. If it's too late and you've already made such a transfer, it might be possible for you to file for Chapter 13 bankruptcy instead. Chapter 13 does not involve liquidation because you enter into a repayment plan supervised by the trustee to compensate your creditors with your disposable income. If you have enough disposable income to qualify, the transfer of your property may not be an issue of fraud.