A Closer Look at Avoidance Actions

In most cases, bankruptcy laws serve to create a safe haven for consumers to protect themselves and their family and give them a fresh start, while at the same time allowing for the monitored distribution of non-exempt estate property to creditors.  Sometimes, trustees presiding over these cases must decide whether or not to take legal action to recover assets or property that was transferred by the debtor before the bankruptcy case was filed.  In the bankruptcy world, these are called avoidance actions.

The bankruptcy trustee can pursue avoidance actions as a way to recover property of the bankruptcy estate and to distribute the property fairly among the creditors of the estate.  The two most common actions that a trustee can pursue are avoidance of fraudulent conveyances and recovery of preferences.

  • Fraudulent Conveyances – There are times when the bankrupt individual might transfer assets prior to filing for bankruptcy.  In some cases, these transfers are done fraudulently with the intent to avoid paying creditors.  Examples include giving money to friends and family, transferring ownership in real property (i.e. deeding away their interest), selling otherwise non-exempt assets or giving away ownership interest in businesses.  When these types of transfers occur prior to bankruptcy, the bankruptcy trustee is required to pursue the recovery of the transferred property so that the property can be fairly divided among the estate’s creditors.  There are limitations, however, as transfers that occurred long before the bankruptcy filing may be considered stale.  The exact time frame for which a trustee can go back and pursue these types of actions will typically depend on the law of the state where the case was filed.  It should also be noted that a finding by the bankruptcy judge that a debtor did transfer assets with a fraudulent intent to defraud, delay or hinder creditors can result in a denial of the debtor’s discharge.
  • Preferences – Preferences occur when the debtor prefers to pay an individual or company prior to the bankruptcy filing, while not paying others.  Preference actions usually do not sit well with creditors, as it can require them to give back all of the money that they were paid. Once the money is returned, the bankruptcy trustee can distribute the assets fairly and equally among all of the debtor’s creditors. Preferences are typically recoverable for payments made to creditors within the 90 day period preceding the bankruptcy filing.  In addition, a trustee can recover payments made within 1 full year prior to the bankruptcy filing if the payments were made to “insiders” of the debtor (i.e. family relatives, business partners, etc.)  There are exceptions to recovery, however, which typically arise in cases where payments made were ordinary recurring payments (i.e. mortgages), or when new value was given by the creditor.
  • Statute of Limitations – There is a time limitation for bankruptcy Trustees to pursue avoidance actions. Under the bankruptcy code, an avoidance action must be commenced within two years from the date the bankruptcy was filed or within one year after the appointment of the Trustee (whichever one is later). It can also be limited by the date the specific case was dismissed or closed.

This information is intended to provide a general overview of what avoidance actions are and how they work.  However, the manner in which avoidance actions may apply to your case may vary depending on the applicable state law, as well as the particular details of your case.  If you have questions or you would like to find out more about how this applies to your specific situation, we invite you to contact us for a free consultation at (703) 549-5000 or by visiting our website.

You can also find out more about these topics by downloading our Free E-Book “Bankruptcy 101” by clicking here.