If you don’t understand clawback in bankruptcy, you might think that bankruptcy involves only what you have when you file. But that’s not how it works.
Bankruptcy law gives a bankruptcy trustee to power to unwind transactions and transfers that diminish what the debtor has on the day the case is filed. The idea is that creditors should not be prejudiced by certain kinds of transfers that shrink the assets available to pay debts.
Sometimes clawback works in the filer’s favor; sometimes not.
So, what kind of transfers are subject to clawback?
In bankruptcy, the trustee can avoid transactions that are
Gratuitous transfers at risk
All too many debtors think that they can keep assets away from creditors by changing how title to the asset is held. A swipe of the pen, and the truck or the boat now belongs to friend or family.
But unless the new titleholder paid fair market value for the asset, the transfer is a fraud on creditors. Anglo Saxon law has long held that you can’t give away your property when you have debts.
Fraudulent transfers are not confined to gifts; a bargain sale to a favored friend is constructively fraudulent, too. The amount of the discount is the measure of the diminution of the assets available to creditors. Selling assets before bankruptcy
Preferences subject to clawback
A preference is a transaction where the debtor pays a creditor on a legitimate debt, close in time to the bankruptcy filing, that gets the creditor more than other creditors get in the bankruptcy.
The look-back period is 90 days for most creditors, and a year for creditors who are “insiders”. The Bankruptcy Code doesn’t give us an exclusive definition of insider. It certainly includes family, affiliated corporations and LLC’s, and their officers. It may include friends or even ex’s.
A preference doesn’t have to involve money. The grant of a lien on an asset can be a preference when it increases the recipient’s share of the estate.
A preference doesn’t have to be voluntary, either. A garnishment or the perfection of a judgment lien is likely a preference.
Transfers after filing bankruptcy
The third kind of transfer subject to clawback in bankruptcy includes the transfer after the moment on which the bankruptcy case is filed.
Think the foreclosure sale that happens minutes after the commencement of the case. That’s post-petition, in bankruptcy lingo, and therefor avoidable.
It also includes the payment by the bank on a check written before filing, but honored after the case is filed. More on the float.
And of course, it includes any attempt by the debtor to transfer assets that are property of the estate after filing.
Contemporaneous transfers are safe
Given this list, you’d think that any commercial activity by the debtor close in time to a bankruptcy filing is suspect. Not so.
Any transaction where the debtor pays money and gets something immediately in exchange is not subject to clawback. So buy groceries or gas, pay for a ticket at the gate, or pay this month’s rent, and you’re good.
Pay on the credit card you used last week to buy groceries, and the transaction may technically be a preference.
Limits on clawback
The most important safe harbor to clawback is simply economic. While a trustee may have the right to recover the payment you made on the credit card, unless the sum of money is significant, it probably costs more to bring a lawsuit in bankruptcy for the amount of the payment than will be recovered.
The amount that a trustee will pursue varies widely. Some trustees will chase a transfer of a few hundred dollars; most want to see a meaningful recovery, after the costs of the litigation, before they file suit. An experienced bankruptcy lawyer can tell you about the local legal culture.
Debtors can clawback, too
Clawback is available to debtors under some circumstances, where the transfer was involuntary and the amount recovered could be claimed exempt.
And, in reorganization chapters like 11 and 13, the debtor has the right to use the clawback powers that are given to a trustee.
Debtors can benefit, too, from trustee clawback. When there are non dischargeable, priority claims in the case, debtors want the bankruptcy estate to go to those creditors first. That lessens the non dischargeable debt that survives the bankruptcy discharge.
Bankruptcy clawback cuts two ways
Understanding clawback in bankruptcy drives both the choice of chapter to file and the timing of any filing. It also should animate your discussion with your bankruptcy lawyer about the details of your financial history so that planning takes in all the relevant facts.