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The Trustee’s Avoidance Powers, Preferential Transfers, and Fraudulent Transfers in Bankruptcy

It is almost always a bad idea to transfer assets prior to filing a bankruptcy. Usually this will raise red flags for the Trustee and the Court and lead them to believe that a debtor is attempting to hide assets. The Trustee can undo or “avoid” certain transfers made prior to the filing of a bankruptcy case. These transfers are usually called “preferential transfers” or “fraudulent transfers”.

A preferential transfer is basically a payment or transfer of property to a creditor prior to filing a bankruptcy case. In order to be “preferential”, the transfer must benefit a creditor (someone you owe money to), must be made while the debtor is insolvent, and is made within 90 days of filing a case, or one year if the transfer is to an “insider”. An “insider” is basically someone closely associated with the debtor, whether that is a friend, parent, sibling, or business partner. If the transfer meets these criteria, the bankruptcy Trustee can undo these transactions.

The best way to illustrate this is through an example. Say Joe borrowed $5,000 from his father in May of 2013. In April of 2013, Joe received his tax refund from the IRS for $6,000. In May, Joe takes the money from the refund and uses it to pay off his debt to his father. If Joe were to file bankruptcy in July 2013, the Trustee would be able to do undo that transfer. Essentially the Trustee would sue Joe’s father to get that money back into the estate; an unpleasant experience for both Joe and his father. The preference would expire in May of 2014, because the transfer was to an insider.

It also important to remember that, while the “preference period” is limited to 90 days or one year, the Trustee has a longer reach-back period to go after “fraudulent” transfers. Under the bankruptcy code, the Trustee has two years to go back and undo a fraudulent transfer. The Trustee can also use state fraudulent transfer law which usually has a reach-back of four years. A “fraudulent” transfer is usually defined as an action to hinder, delay, or defraud creditors. It is usually one where a debtor receives less than reasonably equivalent value for the property transferred and is either: 1) made while the Debtor is insolvent and/or 2) made for the benefit of an insider.

A typical example of this would be:  In January 2012, Joe’s debts far outweigh his assets and he hasn’t been paying his bills. Acme, Inc. got a judgment against Joe for $10,000 in April of 2012. In May of 2012, Joe decides to transfer his 1969 Ford Mustang (worth $20,000) to his son, Junior, for $1.00 to protect it from Acme taking the vehicle. In July of 2013, Joe decides to file bankruptcy.  First off, Junior is definitely an insider. The car at the time of the transfer was worth $20,000 and Joe only received $1.00 for it. Joe knew that he had a judgment against him from Acme at the time of the transfer. This would constitute a fraudulent transfer in the eyes of the Trustee. The Trustee could sue Junior to recover the vehicle, as May 2012 is clearly within the bankruptcy code’s two year window.

The moral of the story is: do not transfer assets prior to filing bankruptcy. Transferring assets can hurt your case and hurt the people you transfer your property to. Don’t consider transferring assets prior to filing bankruptcy without at least talking to a knowledgeable attorney. The attorneys at Fears | Nachawati would be happy to guide you and advise you what your best course of action.