The Bankruptcy Trustee and Preference Claims

The bankruptcy trustee can undo certain financial transactions that occurred before your bankruptcy filing.

Updated by , Attorney

The Chapter 7 bankruptcy trustee, the official assigned to administer the case, has certain "strong-arm" or avoiding powers that allow the trustee to reach back and undo certain transactions before your Chapter 7 bankruptcy filing. Among these are "avoidable preferences" or payments that unfairly favor one creditor over others.

Read on to learn how to recognize avoidable preferences and the trustee's process to undo those transactions or read more about the bankruptcy trustee.



What Are Avoidable Preferences in Bankruptcy?

An avoidable preference is a payment made before filing for bankruptcy that prefers one creditor over others similarly situated. The point is to make sure that all creditors have an equal chance to get paid instead of one creditor getting all of a bankrupt debtor's assets.

The transactions can be voluntary (you wrote a check to the creditor) or involuntary (the creditor garnishes your bank account). The look-back period, or time that the trustee can go back to unwind these transfers, is ninety days for general creditors and one year for insiders. Insiders are relatives or someone with a close or influential relationship with you (see more below).

The bankruptcy law sets minimum amounts for avoiding preferential transfers. In cases not involving insiders, the trustee will only be interested in pursuing transfers equal to or greater than an aggregate of $600 in cases where the debt is primarily consumer debt and $7,575 in cases where the debt is not primarily consumer debt. The second category would be a "business" bankruptcy case. (11 U.S.C. § 547(c)(9).) These figures are subject to change on April 1, 2022, and every three years thereafter.

The Ultimate Preference: Insider Payments

When you complete Your Statement of Financial Affairs for Individuals Filing for Bankruptcy (sometimes referred to as SOFA), you'll disclose whether you've paid on a debt owed to an insider or paid an insider's debt during the year before you filed your bankruptcy case. In bankruptcy, an insider is someone close to you, such as a family member, a business partner, or a relative of a business partner.

What's the purpose of SOFA? SOFA is one of the forms that the bankruptcy trustee—the official tasked with managing your case—will review for fraud and unfair practices. The trustee has the power to unwind transactions and recover funds for the benefit of creditors. Anyone who received money or property that should have remained in the bankruptcy estate will have to give it back. You'll also disclose debt payments made to creditors over the established limits on this form.

Why must insider payments be disclosed? Family members and business associates have avoided creditors by transferring assets to each other for as long as courts have recorded case law—and it's still a common occurrence. It's considered unfair to give insiders payment priority over your other creditors. Creditors must receive payment according to the priority ranking system outlined in bankruptcy law. As a result, you'll have to disclose such transactions when you complete your paperwork.

What would happen if I made an insider payment? If it has occurred, you can expect the trustee to take steps to get the funds or property back. If you hide a transaction, however, and the trustee later discovers it, the trustee will not only unwind it, but you'll be subject to fines and penalties of up to $250,000, 20 years in prison, or both. If you believe that you'll have to report an insider transaction on your statement, it's best to consult with a bankruptcy attorney before moving forward.

The rationale behind these avoiding powers is that all creditors similarly situated should be treated the same. Once the trustee collects all of your money or property and liquidates (converts to cash) the property, the trustee can redistribute the funds equally among similarly situated creditors and per the disbursement schedule set out in the bankruptcy law.

To learn more about avoidable preferences, see Payments Made to Creditors Before Bankruptcy: Can the Trustee Get the Money Back?

How Does the Bankruptcy Trustee Undo Preference Transfers?

While the trustee is granted these strong-arm powers under the bankruptcy law, the transfers' recovery is not automatic. The trustee must demand the money or property return, but the creditor has no legal obligation to return the funds until the trustee obtains a judgment from the court. A creditor can use this period to do its own investigation and perhaps work out a settlement for less than the full amount with the trustee. Here's how this works.

Before the 341 Meeting: Review of Schedules, Statements, and Preliminary Documents

In the first step of the process, the trustee will look for any avoidable transfers by reviewing your bankruptcy schedules and statements and any bankruptcy documents you must provide before the 341 meeting of creditors.

At the Creditors Meeting: The Trustee's Initial Inquiry and Testimony

Depending on the circumstances, the trustee might ask questions about transactions occurring before you filed for bankruptcy at the 341 (or creditors) meeting. Because multiple bankruptcy filers usually attend the creditors' meeting, the trustee will have only a few minutes to conduct the initial inquiry before moving to the next case. So if the trustee suspects transfers, you can expect the trustee to continue the meeting so the trustee can spend more time on the case. Also, the trustee might request that you provide additional documentation to the trustee's office.

To learn more, see The Meeting of Creditors in Chapter 7 Bankruptcy.

After the Creditors Meeting: Trustee Follow-up and Demand Letters

Even if the trustee doesn't request additional documentation at the creditor's meeting, a trustee who suspects transfers will likely request additional documentation or information later. The trustee will likely phone your lawyer, but the trustee could send a letter or take more extreme measures.

When a trustee suspects a serious problem exists, the trustee (or someone else involved in the matter) can set a type of deposition called a 2004 examination to obtain more formal testimony and document production. This will not always involve you.

Under Bankruptcy Rule 2004, anyone can obtain testimony and document production. The trustee is looking for

  • documentation of the transfer
  • evidence that the transfer allowed the person receiving it to be paid a greater percentage of their claim than the creditor would have received if the debtor did not make the transfer and the creditor received payment through the bankruptcy proceeding, and
  • information on possible defenses.

The Trustee's Adversary Proceeding (Clawback Suits)

The trustee will file an "adversary proceeding" or lawsuit once the trustee has determined that:

  • an avoidable preferential transfer took place
  • there are insufficient defenses to the recovery of the transfer, and
  • the recipient has refused to voluntarily return the transferred money or property.

You might hear these avoidance actions sometimes referred to as "clawback" suits.

The recipient, now a defendant in the adversary proceeding, will have an opportunity to respond to the trustee's action and present defenses to the recovery of the alleged preferential transfer. For example, these defenses may include:

  • new value (the creditor loaned the recipient more money after receiving the transfer and was not paid back)
  • contemporaneous exchange (the recipient received something of equal value in exchange for the transfer when it was made), or
  • ordinary course (the recipient made the transfer under ordinary business terms).

After considering the evidence, the court will decide whether to find for either the trustee or the recipient. If the recipient has to return a preferential transfer, the recipient becomes a creditor and can file a claim in the bankruptcy proceeding.

For more information, see Adversary Proceedings in Bankruptcy.

Need More Bankruptcy Help?

Did you know Nolo has been making the law easy for over fifty years? It's true—and we want to make sure you find what you need. Below you'll find more articles explaining how bankruptcy works. And don't forget that our bankruptcy homepage is the best place to start if you have other questions!


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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 hiring a local bankruptcy lawyer.

Updated April 25, 2022

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