Avoidance – Preferential Transfers and Fraudulent Transfers

When a person files bankruptcy a Bankruptcy Trustee is assigned. These Trustees have the power to initiate litigation to “avoid” certain transactions for the benefit of the Bankruptcy Estate and its Creditors. For the Trustee to “avoid” transactions they must file an adversarial proceeding. An Adversarial proceeding is a civil lawsuit filed inside of a Bankruptcy case. Two of the most common avoidance actions are Preferential Transfers (11 U.S.C §547) and Fraudulent Transfers (11 U.S.C. §548). These avoidance actions must be filed the later of two years after entry of the order for relief or one year after the appointment or election of the first trustee. Essentially, the Trustee will sue the party who received the property to be avoided and seek to take back the property so it can be part of the estate.

1. Preferential Transfers

The trustee may avoid certain transfers made within 90 days (and in some cases, one year) preceding the bankruptcy filing that would otherwise benefit one or more creditors at the expense of other creditors. The purpose is equality of distribution among creditors and creditors are encouraged to forbear because they know they will not be permitted to keep the fruits of their collection efforts if the debtor files bankruptcy.

To prevail the Trustee must show that there was 1. A transfer; 2. Of the debtor’s property; 3. To or for a creditor’s benefit; 4. On a debt that existed prior to the filing of the bankruptcy (antecedent debt); 5. Within 90 days prior to filing the petition or within one year if the transfer was an insider; 6. Made while the debtor was insolvent; 7. That prefers the creditor receiving the transfer.

A transfer is not preferential unless it enables the transferee creditor to receive more than what the creditor would have received in a hypothetical Chapter 7 case had the transfer not occurred. Also, a transfer may not be an avoidable preference if the difference between what the creditor received as a result of the transfer and what it would have received in a liquidation is minimal. Prepetition transfers to a creditor who is fully secured on the petition date are generally not preferential because the secured creditor is entitled to 100% of its claim in a Chapter 7 case.

2. Fraudulent Transfers

A “fraudulent transfer” is a transfer of “some property interest with the object or effect of preventing creditors from reaching that interest to satisfy their claims” or “an act which has the effect of improperly placing assets beyond the reach of creditors. Fraudulent Transfers include 1. Transfers made or debts incurred with actual intent to defraud; 2. Transfers made, or debts incurred for less than reasonably equivalent value; 3. Transfers to or for the benefit of an insider under an employment contract; 4. Transfers or debts incurred by an insolvent partnership debtor to a general partner of the debtor; 5. Transfers of property by the debtor to a self-settled trust (or similar device).

Usually there must be a showing of fraudulent intent. However, a transaction is constructively fraudulent if a transfer is for less that reasonably equivalent value and the debtor was insolvent.