Bankruptcy Clawbacks of Preferential & Fraudulent Transfers

A “clawback” in bankruptcy allows a bankruptcy trustee to "void" or undo a transaction and get the money or property back for the benefit of creditors. The clawback provision can recover money paid to a particular creditor before bankruptcy or property transferred to someone else a year to ten years before filing for bankruptcy. Read on to learn more about the clawback provision in bankruptcy.

When the Bankruptcy Trustee Will "Clawback" Payments

If you fraudulently transfer property before filing for bankruptcy or pay only your favorite creditors in a "preferential" transfer of funds, the trustee can recover the money or property. The trustee will "liquidate" or sell the property and distribute recovered funds according to the bankruptcy priority payment rules.

Fraudulent Transfers

Fraudulent transfers happen when the debtor intends to hide assets or transfer property for less than the fair market value before bankruptcy. The trustee will take steps to void a transfer and recover money or property if:

• the transfer occurred within two years before bankruptcy or the time limit allowed by state law for setting aside fraudulent transfers, whichever is greater, and
• the transfer was intended to delay, hinder, or defraud creditors (actual fraud), or
• less than fair market value was received for the property while the debtor was insolvent.

A transaction might also be fraudulent if the debtor became insolvent due to the transfer or purposefully intended to incur more debt than the debtor could afford to repay.

If the transferred asset had no equity or would have been protected or “exempt,” the trustee typically won’t file a motion asking the bankruptcy court to void it as fraudulent. Learn more about how bankruptcy exemptions protect your property in bankruptcy.

Preferential Transfers

Preferential transfers include certain payments or transfers of property to creditors made before filing for bankruptcy. For example, paying back a large loan or your rent months in advance before you file for bankruptcy will typically be considered a preferential debt payment.

Whether the trustee can void a transfer and require the property's return depends on the payment's value, timing, and who received it.

Paying Loans to Insiders

Paying back a loan from a family member shortly before bankruptcy is a classic example of an insider preferential transfer. Whether the trustee can avoid the transfer and get the money back for the benefit of your creditors will depend on numerous factors. Here’s how it works.

The rules are strict if you pay a creditor who is an insider. The trustee can seek to avoid insider payments made within one year of the bankruptcy. Insiders include more than your relatives but extend to:

• your general partner
• the relatives of your general partner
• partnerships in which you are a general partner, and
• corporations of which you are an officer, director, or person in control.

If you don’t want the trustee to bother a family member or some other insider by demanding the return of the preference payment, you can pay the trustee the amount yourself.

Paying Other Creditors

The rules are different for other creditors. If most of your debt is consumer debt—that is, it isn’t a business debt—a payment or transfer to a creditor is a preference when it’s:

• over $600 in aggregate (as of October 2024)
• paid within the 90 days before your bankruptcy filing, and
• more than the creditor would be entitled to in a Chapter 7 bankruptcy.

If the payment meets all elements, it qualifies as a preference. The trustee can avoid the transfer and get the money back for the benefit of all creditors. Bankruptcy law presumes debtors are insolvent during the 90 days before filing for bankruptcy.

If most of your debt is business debt, the amount that can be paid to creditors before filing is higher. The total amount is $7,575 (as of October 2024). Find out more about small business bankruptcy.

Disclosing Insider and Creditor Payments

You’ll list preferential payments on one of the forms you’ll fill out when you file for bankruptcy—the Statement of Financial Affairs for Individuals Filing for Bankruptcy. You’ll find a downloadable copy on the U.S. Court bankruptcy form webpage. The trustee will review the form and look for these types of transactions.

Learn about red flags the trustee looks for in the bankruptcy paperwork.

How to Avoid the Clawback Provision

Suppose you made a transfer that could be considered preferential or fraudulent. In that case, the timing of your bankruptcy filing will be important. But be aware that delaying your bankruptcy to avoid paying creditors can result in the loss of your property, the loss of your discharge, or even a criminal investigation if the court believes you intentionally committed bankruptcy fraud.

When to Seek Bankruptcy Advice

You’ll have a lot of factors to consider when deciding whether to file a bankruptcy case—especially if you need to file fast. Weighing and balancing the benefits received in bankruptcy is common, and it isn’t unusual to have to pay the trustee some amount or relinquish property in a Chapter 7 case.

In most instances, filing will be a good decision if the total debt amount wiped out in bankruptcy exceeds what you must pay. A knowledgeable bankruptcy lawyer can explain the pros and cons presented by your particular case.