QUESTIONS & ANSWERS
Bankruptcy Litigation FAQs
- What is a preference?
- Are there defenses to a preference lawsuit?
- What is a fraudulent transfer?
- What is an avoidance action?
What is a preference?
The Bankruptcy Code gives a trustee (or the debtor in a Chapter 11) the ability to recover money paid to some creditors for redistribution in accordance with Bankruptcy Code. In generally, a payment from the debtor made within 90 days before the bankruptcy was filed can be recovered by the trustee if the debtor was insolvent when the payment was made and the payment provided the creditor with more than would have been received in a Chapter 7 case. If the creditor was closely connected to the debtor or its owners, then the reach-back period may be one year before the bankruptcy was filed.
Preference actions often seem unfair to creditors who had to wait for payment from the debtor, were finally paid, and then are sued by a trustee who wants to recover the payment. The policy that Congress intended in allowing a trustee to recover a preference is to put the recipient of a preferential payment in the same position as a creditor in the bankruptcy, resulting in an equality of distribution.
Are there defenses to a preference lawsuit?
The Bankruptcy Code includes several defenses. If the payment was in the ordinary course of business, it may to be recoverable. If you gave something of value at the time of the payment, or after the payment, the value that you gave will serve to reduce the preference. If you had a lien on property when the payment was made, this may serve to defeat the preference claim brought by the trustee. In most cases, trustees will settle preferences for less than face value. It is important to consult with an experienced bankruptcy attorney to assist you in minimizing the effects of a preference claim brought by a trustee.
What is a fraudulent transfer?
The Bankruptcy Code recognizes two types of “fraudulent transfers”. The first involves a transfer made by the debtor with the actual intent to avoid creditors. The second involves a transfer made by an insolvent debtor for which less than “reasonably equivalent value” is received. If you are sued by a trustee for receipt of a fraudulent transfer, it does not necessarily mean that the trustee is accusing you of fraud. It is enough that you received more than you gave back to the debtor.
Defenses to a fraudulent transfer action generally turn on arguments as to valuation. An experienced bankruptcy attorney can assist you in presenting your case to defend the claims.
What is an avoidance action?
Both preference actions and fraudulent transfer actions are “avoidance” actions. The term “avoidance” is sometimes used to refer to a lawsuit asking the bankruptcy to invalidate a transfer or lien. If a transfer is avoided, the property transferred must be returned. If a lien is avoided, a creditor may lose its rights in collateral. The Bankruptcy Code and other applicable law sometimes provide several bases for avoiding transfers and liens.