With the state of the US economy remaining relatively stagnant over the years, fewer Americans are filing for chapter 7 bankruptcy, but the numbers still remain relatively high. There were 699,982 chapter 7 bankruptcy fillings in 2014. Chapter 7 bankruptcy is perhaps one of the simplest form of bankruptcy. Approved applicants simply surrender all of their assets, which will be liquefied and distributed to creditors; however, there are some exceptions to the rule. In particular, trustees must pay particular attention to the earmarking doctrine.
A Brief Look at the Earmarking Doctrine
The earmarking doctrine is a simple legal note that states that money acquired or set aside for a certain purpose is not to be considered as a part of the debtor's estate when he or she files for bankruptcy. In general, this situation happens when a company or an individual takes out a loan from a new source in order to pay back a creditor. Because the money loaned was technically never an official part of the debtor's estate, the bankruptcy trustee will not be granted access to it. In short, the money has been reserved for a particular purpose and cannot be used for anything else.
Since chapter 7 bankruptcy involves surrendering all assets to be liquefied by a bankruptcy trustee, the earmarking doctrine interferes with the trustee's ability to be granted access to all assets. If a loan or an asset has been earmarked, the funds must be set aside as payment for a specific creditor. There are no exceptions on how the funds can be used. The law will not allow these funds to be distributed to other creditors.
The 3 Elements of the Earmarking Doctrine
To determine whether a certain loan qualifies under the earmarking doctrine, the bankruptcy trustee must determine whether the loan meets one of the three elements. The bankruptcy courts must also verify the findings and confirm that the loan is indeed protected under the earmarking doctrine. The three elements include the following:
- The presence of an agreement between the lender providing the loan to the debtor regarding where the new funds will be allocated;
- Evidence that the new loan has been used to pay back a specific existing debt; and,
- The transaction viewed as a whole does not diminish the value of the debtor's estate.
The debtor should establish which assets are earmarked when filing for bankruptcy, as this will affect their financial standing significantly. The bankruptcy trustee must then review and verify all claims being made. The bankruptcy trustee has the burden of proof of establishing that the transaction does diminish the debtor's estate. If the trustee finds that the loan does not meet the requirements, he or she must file a claim to the bankruptcy courts for the loan to be formally reviewed.
Proof Required to Establish an Asset is Earmarked
To ensure that the bankruptcy trustee will not be granted access to the funds, the debtor and the lender must have a written agreement for the loan. The written agreement must specifically state the amount that was loaned, how the loan will be distributed to a specific creditor, the terms of repayment and the consequences of failing to repay the loan.
In short, if you have borrowed money from a family member, friend or a loan company, the money borrowed is considered to be earmarked – that is, if you can prove it. Any funds that have been earmarked cannot be included in the calculation of the total value of the debtor's estate. The funds also cannot be used to pay off any other creditors than who they were originally intended for. For more information, contact a firm such as Wiesner & Frackowiak, LC.