Bankruptcy Clawbacks of Preferential & Fraudulent Transfers

A "clawback" in bankruptcy allows a bankruptcy trustee to "void" (undo) a transaction and get the money or property back for the benefit of your unsecured creditors. A trustee will use the clawback provision to get back money paid to a particular creditor before bankruptcy. The trustee will also use the clawback provision to recover property you transfer to someone else a year to ten years before filing for bankruptcy.

Read on to learn more about the clawback provision in bankruptcy.

When Can the Bankruptcy Trustee Use the Clawback Provision?

If you fraudulently transfer property before filing for bankruptcy or pay only your favorite creditors, the trustee can recover the money or property. The trustee will "liquidate" or sell the property and distribute the sales proceeds according to the bankruptcy priority payment rules. These rules explain the order the trustee is to pay different types of creditors.

Fraudulent Transfers

The trustee can also use the clawback provision to undo fraudulent property transfers. In general, fraudulent transfers include those made with the intent to hide assets or transfers of property for less than the fair market value before bankruptcy. The trustee may have grounds to void a transfer and recover the property if:

• you made the transfer within the two years before your bankruptcy or within the time limit allowed by state law for setting aside fraudulent transfers, whichever is greater, and
• you intended to delay, hinder, or defraud your creditors (actual fraud), or
• you received less than fair market value for the property transferred while you were insolvent, became insolvent due to the transfer, or intended to incur more debt than you could afford to pay back (constructive fraud).

However, if the asset transferred had no equity or would have been exempt, the trustee will typically not void the transfer 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 loan from your parents just before you file for bankruptcy will typically be considered a preferential debt payment. Whether the trustee can void a transfer and claw back the property depends on the payment's value, timing, and recipient.

Here are the rules:

Payments or transfers made within 90 days of bankruptcy. If in the 90 days preceding your bankruptcy, you transferred money or property worth over $600 in aggregate to one of your creditors while you were insolvent (meaning you had more debts than assets) and that payment resulted in the creditor getting more than it would have been entitled to through your bankruptcy, it is considered a preferential transfer. In most cases, the trustee doesn't have to prove insolvency because bankruptcy law automatically presumes that debtors are insolvent 90 days before their filing date.

Payments or transfers to insiders. The same rules discussed above also apply to transfers of money or property to insiders (such as friends, family members, or business partners). However, instead of 90 days, the transfer will be considered preferential even if made within one year before your bankruptcy filing date.

Can I Pay Back a Loan to a Family Member?

Paying back a loan from a family member shortly before bankruptcy is the classic example of a preferential transfer, but not in all situations. 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.

Family Members Are Insiders

If you make a payment to a creditor who is an insider, the rules are strict. The trustee can 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 pay back a loan from your family within one year before filing your case, the trustee can avoid the transfer and get that money back if all other preference requirements are satisfied.

Making Payments to Other Creditors 90 Days Before Filing

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,
• paid within the 90 days before your bankruptcy filing
• made while you were insolvent (meaning you had more debt than assets and property), and
• more than the creditor would be entitled to in a Chapter 7 bankruptcy.

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

If most of your debt is business debt, the amount you can pay creditors is higher. The aggregate amount is $7,575. Find out more about small business bankruptcy.

Where You'll Disclose Family Loan 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 looking for these types of transactions.

Keep in mind that 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. It isn't unusual to have to pay the trustee some amount or to relinquish property in a Chapter 7 case.

If you don't want the trustee to bother a family member by demanding the return of the preference payment, you can pay the trustee the amount yourself. In many cases, the total debt amount wiped out in the bankruptcy will exceed what you'd have to pay.

How to Avoid the Clawback Provision

If you made a transfer that could be considered preferential or fraudulent, 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 lead to a criminal investigation if the court believes you intentionally committed bankruptcy fraud.

Need More Info?

We want to help you find the answers you need. Go to AllLaw's Topic page for more easy-to-understand bankruptcy articles, or consider buying a self-help book like The New Bankruptcy by Attorney Cara O'Neill.

We wholeheartedly encourage research and learning, but online articles can't address all bankruptcy issues or the facts of your case. The best way to protect your assets in bankruptcy is by consulting with a local bankruptcy lawyer.

Updated April 25, 2022