Fraudulent Conversion of Money To Homestead in Chapter 7 Bankruptcy

Bankruptcy is very hard on wealthy debtors. In a Florida Chapter 7 bankruptcy case decided last month (March) a bankruptcy court applied the 10 year look-back provided for in Section 522 of the U.S.  Bankruptcy Code to deny a homestead exemption because the court found that the home was purchased with the intent to defraud creditors.

Here is a  concise summary of the facts. The debtors, husband and wife, purchase a lot 2005 to build a future homestead. In 2009, the debtors faced default on at least two large real estate debts. About the same time they were going in to default on the loans the debtors converted almost all of their non-exempt assets to construct a “dream home” of approximately 5,500 square feet.

The court concluded that the debtors intended to shield all their non-exempt assets from the real estate creditors when they knew they were about to default. The court found that the debtors had enough money to service the loans, but instead, they converted all this money to their homestead with intent to avoid payment. The court disallowed the debtors’ homestead exemption to the extent of non-exempt funds invested in the homestead to avoid creditors.

This case leaves one wondering why the debtors even considered Chapter 7 bankruptcy. The debtors had a solid asset protection plan so long as they stayed away from bankruptcy. In state court, there is not cause of action for fraudulent conversion of money in to a Florida  homestead. Here, even where the facts showed a clear intent to hide money in a homestead on the eve of default, the creditors had no remedy in state court. Once the debtors voluntarily filed bankruptcy they exposed their homestead to the bankruptcy trustee and creditors. In bankruptcy, a fraudulent conversion of money to a homestead within two years of filing may result in denial of discharge, and conversion between two years and 10 years with intent to defraud creditors jeopardizes the homestead exemption.

As I have written previously in many blog post, debtors with significant assets should be wary of filing bankruptcy because they give up many legal and practical protections. .