December 15, 2018

Gifts vs. Loans – Big Differences in Bankruptcy Court

I recently ran across an interesting blog post from Mark Markus, a bankruptcy lawyer in Los Angeles, who noted that the characterization of a your receipt of money as a gift is significantly different from characterizing that receipt of money as a loan.

If the funds received are a gift, the funds would count as income for means test purposes and these funds (assuming they are not yet spent) would be an asset of your bankruptcy estate and potentially reachable by a bankruptcy trustee.

By contrast, if funds received are treated as a loan, these funds would not count as income for means test purposes, although cash still on hand would be an asset.

Mr. Markus also notes that if you pay back the lender before filing, the repayment could have bankruptcy implications.  He is referring to the issue of preferences, which are provisions of the Bankruptcy Code that allow trustees to recover money from lenders in certain situations.

Your lawyer can advise you regarding the preference issues and about the means test as well as exemptions that can allow you to protect cash and other property from the trustee’s reach.  However, as Mr. Markus points out a threshold question is whether funds received are a gift or a loan.  What are the differences?

The main distinction between a gift and a loan has to do with intent – do you and the lender  intend that the funds you now have are to be repaid.  Ideally, you are the lender will enter in to a written contract at the time the funds are released that sets out a repayment schedule, applicable interest and the consequences of default.

This type of formal contract can be essential to proving that you entered into a loan contract and you should create such a contract even when transacting with family members.

If no contract was entered into at the time of the money transfer, an oral agreement can be formalized later, but such a contract should be drafted by a lawyer to increase the chances that it will pass the scrutiny of a judge.

Judges will look at other transactions between the parties.  If your father has written you 15 checks over the past two years, and there is no contract and you have not paid anything back, it will be difficult to argue on the eve of bankruptcy that these payments are loans and not gifts.

If you have lent or received money and you are uncertain whether these transactions are loans or gifts in the eyes of the law, please contact our office.