How Clawbacks Can Affect the Progress of a Chapter 11
Clawbacks are mechanisms that allow a Chapter 11 bankruptcy trustee or debtor-in-possession (DIP) to recover certain payments or asset transfers made by the debtor prior to or shortly after filing for bankruptcy. These provisions aim to ensure equitable treatment of creditors and prevent debtors from unfairly preferring certain creditors or transferring assets to hinder creditor recovery.
Clawbacks can apply to preferential transfers and fraudulent transfers.
A preferential transfer is a payment or transfer made by the debtor to a creditor within the 90 days preceding the bankruptcy filing (or one year if the creditor is an insider) that gives the creditor more than they would have received in a Chapter 7 liquidation. Under Bankruptcy Code § 547, a trustee seeking a clawback must demonstrate that — The transfer was to or for the benefit of a creditor, that It was made for an antecedent debt, that it enabled the creditor to receive more than they would under Chapter 7 and that the debtor was insolvent at the time of the transfer.
A fraudulent transfer is a transaction made with the intent to hinder delay, or defraud creditors or for which the debtor received less than reasonably equivalent value. These can consist of actual fraud, where there is intent to defraud creditors, or constructive fraud, based on the lack of reasonably equivalent value. Under Bankruptcy Code § 548, a trustee can recover fraudulent transfers made within two years before the bankruptcy filing. State fraudulent transfer laws, such as those under the Uniform Fraudulent Transfer Act (UFTA), may extend the reach-back period to four years or more.
Debtors or transferees in a Chapter 11 can raise several defenses against clawback actions, including:
- Contemporaneous exchange for value — If the transfer was a substantially contemporaneous exchange for new value provided to the debtor, it is not recoverable. This defense applies to transfers made in the ordinary course of business.
- Ordinary course of business — Transfers made in the ordinary course of business or according to ordinary business terms are protected. This defense encourages creditors to continue dealing with financially distressed companies.
- Security interest acquired — Transfers that perfect a security interest within a defined period (e.g., 30 days) in connection with new value are protected.
- Subsequent new value — A transferee that provided new value to the debtor after the challenged transfer can offset the new value against the clawback claim.
- Good faith — A transferee who accepted the transfer in good faith and provided value may retain the property up to the value provided.
Under Bankruptcy Code § 546(a), a trustee must file a clawback action within two years of the bankruptcy filing or one year after the trustee’s appointment, whichever is later.
The Law Offices of Michael Jay Berger in Beverly Hills is one of Southern California’s most experienced Chapter 11 bankruptcy law firms, with 12 locations across the region. If your company needs help with debt reorganization, call 310-271-6223 or contact us online to schedule a free consultation.
