Family members like to help each other. That’s a good thing; families should stick together. But helping a family member by providing financial assistance can backfire if the family member faces bankruptcy.
Parents often proudly present their young-adult children with a new car to help them on their way. But, if the new car owner faces financial trouble and files bankruptcy, that gift can create a big problem in the bankruptcy. In a Chapter 7 bankruptcy, a trustee reviews all assets owned by the debtor to see if the assets have enough value to sell, in order to raise money to pay creditors. The average individual or couple filing bankruptcy will have a “no-asset” bankruptcy estate; their home has value, but the mortgage amount is near the value, leaving little equity to interest a trustee. The car has value, but it’s financed, and likely to be worth little more, or even less, than the loan amount. The ordinary household goods don’t have enough value to justify a trustee opening a bankruptcy estate, hiring lawyers and accountants, just to raise a few dollars.
However, if the debtor owns a car that is paid for, or was a gift, the trustee may have property that he or she can sell. Suppose you bought a vehicle for $25,000 or $30,000 and gave it to your family member. The trade-in or sale value might still be $15,000 or $20,000. That’s enough for a trustee to pick up the car and sell it. Bankruptcy law provides for “exemptions” to protect a minimal value in every kind of asset, and in Illinois the vehicle exemption is $2,400. That still allows the trustee to sell the car, take the $15,000 or $20,000 sale price, and pay the debtor the $2,400 exemption. The car is gone, and the debtor has $2,400 in cash, and a tough time buying another car with bad credit and a bankruptcy.
What if the parent keeps title in is or her own name, and lets the young adult drive the car? That raises problems of its own, including the fact that the owner of a vehicle may be held liable if the car is involved in an accident.
The safest, although most complicated, way to protect all the parties is to sell the vehicle to the young adult and take payments over time. The parent has the adult child sign a promissory note and a security agreement (you will want to involve a lawyer) and note the security interest on the vehicle title, just like a bank lender. File the title with the Secretary of State. You can make a gift of the installment payment every month, but keep track of the amount that still remains due on the note. By the time the loan is repaid, the value of the car will have come down to an amount that the average trustee will not bother with.
If you don’t want to go through this paperwork, but the parent (or other relative) wants to keep ownership of the vehicle, the debtor who is driving the generous relative’s car must be careful to let his or her bankruptcy lawyer know about the arrangement. There are questions on the bankruptcy schedules about property that you possess and use, but if it is owned by someone else, you want to be sure you answer those questions correctly. Don’t let generosity cause problems for your family!