Complaints to Recover Fraudulent Transfers in Bankruptcy

In certain situations, if you transfer property prior to bankruptcy, the bankruptcy trustee can get it back to repay your creditors.

If you transfer property out of your name or make payments to preferred creditors before filing for bankruptcy, the bankruptcy trustee assigned to your case may file a complaint (called an adversary proceeding) to void the transfer and recover that money or property. This is also commonly referred to as a bankruptcy clawback. Read on to learn more about when the trustee might file a complaint in bankruptcy to recover fraudulent transfers or preferential payments.

Reasons the Trustee Might File a Complaint to Recover Property in Bankruptcy

The trustee might file a complaint in your bankruptcy to void a transfer and recover the money or property for the benefit of your creditors if you make a:

  • fraudulent transfer, or
  • preferential payment.

Fraudulent Transfers in Bankruptcy

Certain property transfers you make before filing for bankruptcy may be considered fraudulent. The trustee can typically void a transfer as fraudulent and recover that property if the transfer occurred during the two-year period before you filed for bankruptcy (or within the time allowed by state law for setting aside a fraudulent transfer), and the transfer constituted

  • actual fraud -- you made the transfer with the intent to defraud, delay, or hinder your creditors, or
  • constructive fraud -- you transferred the property for less than it was worth and you were insolvent at the time (or became insolvent because of the transfer), engaged in a business transaction that left you with an unreasonably small capital, intended to incur more debt than you had the ability to pay, or made the transfer to or for the benefit of an insider under an employment contract.

Definition of insolvency. In general, you are considered insolvent if your debts exceed the value of your assets. But keep in mind that when determining whether you were insolvent, the court will typically not take into account the value of your exempt property or any assets you transferred or concealed with the intent to defraud, delay, or hinder your creditors.

Difference Between Actual Fraud and Constructive Fraud

The main difference between actual fraud and constructive fraud is whether or not you intended to defraud, delay, or hinder your creditors when you made the transfer.

Actual fraud. Actual fraud requires the trustee to prove that you transferred the property with the intent to defraud your creditors. For this reason, it’s harder to prove than constructive fraud.

Example. Frank owns a boat worth $50,000 free and clear. Frank is planning to file for bankruptcy but knows that the trustee will sell his boat to pay back his creditors if he does. To keep the boat from his creditors, he transfers it to his friend before filing for bankruptcy. Because Frank transferred his property with the intent to defraud his creditors, this would constitute actual fraud.

Constructive fraud. Constructive fraud doesn’t require the trustee to prove intent. This means that the trustee may be able to void a transfer as constructively fraudulent simply by showing that the transfer meets the constructive fraud requirements discussed above. Most fraudulent transfer actions involve debtors who transfer property for less than it’s worth while they are insolvent.

Example. Ann’s only asset is a car worth $15,000. But she has credit card debt in excess of $25,000. Ann is not contemplating filing for bankruptcy but needs some quick cash to cover her expenses. To get the money quickly, she sells her car to her friend for only $9,000. If Ann subsequently files for bankruptcy, the trustee may argue that this transfer was constructively fraudulent even though Ann never had an actual intent to defraud her creditors.

Preferential Payments in Bankruptcy

Sometimes a payment or transfer you make to a creditor before filing for bankruptcy may be considered a preference (or a preferential payment). If the trustee believes that you made a preferential payment, he or she can file a complaint to recover that money for the benefit of all your creditors.

The trustee will typically have grounds to argue that you made a preferential payment if you made a payment or transfer of over $600 in aggregate to any creditor within the 90-day period preceding your bankruptcy while you were insolvent, and that payment allowed the creditor to receive more than it would have in your Chapter 7 bankruptcy. When determining whether a payment was preferential, the bankruptcy court presumes that you were insolvent during the 90 days before your bankruptcy.

Also, keep in mind that if the creditor was an insider (such as a relative or business partner), the payment can be considered preferential if it was made within one year of your bankruptcy filing. (To learn more, see The Clawback Provision and Preferential Transfers.)

Talk to a Bankruptcy Attorney

If the trustee files a complaint to recover a fraudulent transfer or preferential payment in your bankruptcy, you will need to respond to the complaint and litigate the issue in court if necessary. If you fail to respond, the trustee may be able to void the transfer and recover the property for the benefit of all your creditors.

In addition, if you made the transfer or payment to a friend, relative, or business partner, it can affect his or her financial circumstances as well as your relationship with that person. For these reasons, talk to a knowledgeable bankruptcy attorney in your area to learn about your options if the trustee alleges that you made a fraudulent transfer or preferential payment.

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