The Bankruptcy Trustee’s Power to Set Aside Certain Payments to Creditors
Debtors planning on bankruptcy often make payments to certain creditors weeks or months ahead of filing. When a debtor makes a payment that unfairly benefits one creditor over others, this is known as an avoidable preference. Whether the payment is made voluntarily (by writing a check to a creditor) or involuntarily (through wage garnishment), the bankruptcy trustee has the authority, known as strong-arm power, to undo the payment, reclaim the money and redistribute it according to the proper priority among all creditors.
The strong-arm power is codified in Bankruptcy Code § 547. It permits the trustee to reverse a payment made by an insolvent debtor to a creditor under these specific circumstances:
- To general creditors within 90 days of filing — For instance, if a debtor makes a substantial payment on a credit card debt a month before filing for bankruptcy in hopes of retaining access to that card post-bankruptcy, the trustee can avoid this payment. The intention is to prevent the debtor from favoring certain creditors over others immediately before filing for bankruptcy.
- To insiders within one year of filing — If a debtor transfers assets to an insider (such as a family member or business associate) within a year before filing, the trustee can avoid this transaction. Examples include transferring a business stake to a relative, selling an asset to a business partner at a significantly reduced price or placing property in a child’s name to keep it within the family. These actions are scrutinized to ensure that the debtor does not unfairly shield assets from the bankruptcy process.
A qualified bankruptcy attorney can play a vital role in assisting debtors faced with trustee avoidance actions. An attorney can also assert available affirmative defenses, such as demonstrating that a payment was a contemporaneous exchange for new value provided to the debtor, or that a payment was made in the ordinary course of business or financial affairs.
To uncover such payments and transfers, trustees review the debtor’s Statement of Financial Affairs (SOFA), which is a mandatory document in bankruptcy cases. The SOFA requires full disclosure of all payments and property transfers made prior to the bankruptcy filing. Failure to accurately report these transactions can result in severe penalties, including up to 20 years in prison, fines up to $250,000, or both. A bankruptcy attorney can assist a debtor in preparing a SOFA that is complete and accurate.
The Law Offices of Michael Jay Berger in Beverly Hills has extensive experience handling avoidances and related proceedings in bankruptcy. Call 310-271-6223 or contact us online for a free consultation.
