The bankruptcy trustee has avoidance powers to ensure equitable treatment of creditors. These powers enable the trustee to cancel transactions that put one creditor in a better position than other creditors. The trustee’s most common avoiding powers are:
- Preferential transfers.
- Fraudulent transfers.
- The ability to set aside certain liens.
A preferential transfer is transfer of property or money to a creditor for payment of a debt when the debtor was insolvent. It is presumed that the debtor was insolvent 90 days prior to filing a petition in bankruptcy, or between 90 days and one year if the creditor is an “insider” or the transfer was made to benefit an insider. The transaction is considered preferential if the creditor receives more than he or she would in a liquidation proceeding. For example:
A debtor who owed his brother-in-law $3,000 for a personal loan wanted to keep peace in the family. He did not want to discharge the loan in bankruptcy, so he paid his brother-in-law the $3,000 45 days before filing bankruptcy. The trustee would consider that payment a preferential transfer of assets because the debtor paid the money to his brother-in-law before other creditors, thereby treating him with preference. Additionally, since the brother-in-law is a family member, he is considered an “insider” and any such payment would be voidable if paid within one year prior to filing bankruptcy. The trustee would void that payment and make the brother-in-law pay back $3,000. The trustee would then apply the $3,000 equally among all the unsecured creditors. The brother-in-law becomes an unsecured creditor, entitled only to a portion of the estate, the same as other creditors. The only way the debtor could repay his brother-in-law before other creditors would be to wait one year after payment before filing bankruptcy. However, if the court found that the payment was made to hinder other creditors from receiving payment, the transfer could be determined to be fraudulent because it was a payment to an insider between 90 days and two years of filing.
Other examples of preferential transfers are payments made on credit cards within 90 days of filing bankruptcy or a lien put on property within 90 days of filing bankruptcy. A payment made for a charitable contribution, such as a religious contribution, may be considered a preferential transfer if it exceeds 15% of the debtor’s gross annual income, or is inconsistent with the debtor’s past contribution practices. This does not mean that all payments made within 90 days of filing bankruptcy are subject to preferential transfer allegations. Payments to fully secured creditors are not preferential because the creditor will not realize more on its claim than it would in a liquidation proceeding. Debts incurred in the ordinary course of business and paid within 45 days of the date the debt was incurred would be exempt from preferential transfer allegations. Preferential transfers are not applicable to spouses, former spouses, or children if the payment is for alimony, maintenance, or support made pursuant to a court order. Also exempt are substantially contemporaneous transactions (e.g., payment of goods and services by check). Additionally, in the case of an individual debtor whose debts are primarily consumer debts, the Bankruptcy Code will not allow the trustee to pursue preferential transfer claims if the total amount is less than $600. If the individual debtor’s debts are not primarily consumer debts, the trustee will not pursue a preferential transfer claim if the total amount is less than $5,850. The trustee has two years from the entry of the order for relief, or one year after appointment of the first trustee if the appointment occurred before the expiration of the original two-year period, to exercise avoiding powers. Once the trustee determines that a transfer was preferential, the trustee will demand that the creditor return the payment or property. Most often, the creditor will return the asset. If not, the trustee may sue the creditor to recover the asset for the benefit of the estate through an adversary proceeding.