Avoidance Actions in Bankruptcy
One of the primary goals of the Bankruptcy Code is to provide for an orderly distribution of funds to creditors. In order to accomplish this goal, the Bankruptcy Code gives the trustee power to bring assets into the bankruptcy estate through the avoidance of certain transfers that occurred prior to the bankruptcy filing. This is accomplished by the trustee filing a lawsuit against those who received the transfers. These avoidance actions generally fall into two categories: fraudulent transfers and preferences.
Two different provisions in the Bankruptcy Code grant the trustee the right to avoid fraudulent transfers. First, section 544(b) provides that the trustee may avoid a transfer that is voidable by a creditor under state law. Second, section 548 provides that the trustee may avoid transfers that were made with the actual intent to hinder, delay or defraud creditors. That section also gives the trustee the power to avoid a transfer if the debtor "received less than a reasonably equivalent value" in exchange for the transfer if the transfer occurred while the debtor was insolvent or if the debtor was rendered insolvent by the transfer.
Section 547 of the Bankruptcy Code allows the trustee to avoid transfers:
- to a creditor
- on behalf of an antecedent debt (a debt that existed before the transfer)
- made while the debtor was insolvent
- made within 90 days before the bankruptcy (or one year if the recipient was an insider), and
- that permit the creditor to receive more than he would receive in a chapter 7 liquidation.
It is important to note that neither the debtor nor the creditor did anything wrong in entering into the transfer. Defendants in preference lawsuits are often very frustrated and angry at being sued when they have done nothing wrong, and for good reason. But the Bankruptcy Code allows the trustee to undo otherwise unobjectionable transactions to make sure that similarly-situated creditors are treated equally in the bankruptcy process. Preference actions ensure that the debtor cannot frustrate the purposes of the Bankruptcy Code by paying certain creditors and not others on the eve of bankruptcy.
The two most common defenses to a preference action are (1) that the transaction occurred in the "ordinary course of business" and (2) that the creditor gave "subsequent new value" to the debtor after the transfer in question was made. If a creditor is required to turn over money or property as a result of an avoidance action, he will have a claim against the bankruptcy estate under section 502(h) for the amount that he was required to turn over.