Both the Bankruptcy Code and Minnesota State law prohibit certain types of transfers of money or property made by the debtor prior to the filing of their bankruptcy case. These prohibited transfers are “avoidable” by the bankruptcy trustee. This means that the chapter 7 trustee can avoid, or undo, the transfer by demanding return of the transferred property from the person or entity to whom the transfer was made, and the trustee can even bring a lawsuit against that person to enforce their legal right to the return of the property.
The theory behind granting the trustee the legal right to avoid such transfers is that the wrongful transfer deprived creditors an opportunity to receive more money than they would have otherwise received had the transfer not occurred. Accordingly, any money recovered by the chapter 7 trustee from such an avoidance will be distributed to the debtor’s other creditors. The two basic types of avoidable transfers are fraudulent transfers and preferential payments.
A fraudulent transfer occurs when the debtor transfers money or property to another, prior to filing their bankruptcy case, and receives less than equivalent value in exchange for the transfer. Section 548 of the Bankruptcy Code provides that the trustee can avoid any such transfer that occurs within the two year period prior to the date that the bankruptcy case is filed. An example would be selling your truck worth $10,000 to your friend for $2,000 (or worse giving to him for free), 6 months before filing bankruptcy. The trustee would be able to avoid this transfer by legally pursuing the $8,000 extra dollars the friend should have paid for the truck, with the theory being that the extra money would have been available to pay the debtor’s other creditors. Keep in mind, the transfer will be considered fraudulent, and avoidable, regardless of whether the debtor actually intended to transfer the property in order to defraud, or avoid their obligation, to the creditors. However, if it could be proven that the debtor did, in fact, transfer the property with the actual intend to defraud, or harm, their creditors, the Court could deny or revoke the debtor’s right to discharge their debts, particularly if the transfer occurred within the one year period prior to their case being filed.
Although the look-back period for avoiding transfers is 2 years prior to the date the bankruptcy case is filed under the Bankruptcy Code, Minnesota Statues Section 513.44 actually provides a 6 year look-back for such transfers. The requirements for a fraudulent transfer under this Statute are similar to Section 548 of the Bankruptcy Code. A fraudulent transfer pursuant to this Statute can be found when the debtor transfers property for less than equivalent value, and essentially, it leaves them in a position in which they are left with substantially less property or without any reasonable ability to repay their debts. This is true regardless of any intent that the debtor has to defraud creditors. Also, the Statute provides that a fraudulent transfer occurs when the debtor actually intends to defraud their creditors and provides certain factors the court can look at to prove intent. These factors include, whether the property was transferred to a family member of the debtor, whether the debtor was insolvent (the value of their assets were less than their debts) around the time of the transfer, whether the debtor was sued or threatened with legal action shortly before the transfer was made, whether the transfer was substantially all of the debtor’s assets, etc. Commonly, chapter 7 trustees use the State Statue in situations in which the debtor transferred property to family members, for less than equivalent value, more than 2 years prior to filing bankruptcy.
Another type of avoidable transfer is known as a preferential payment, which is governed by Section 547 of the Bankruptcy Code. A preferential payment occurs when the debtor, prior to filing their bankruptcy case, makes payments to any creditor in an amount that unfairly benefits that creditor in relation to the other creditors. When the creditor is an ordinary creditor (i.e. doesn’t have a special relationship with the debtor), a preferential payment occurs when that creditor receives a total of over $600 in the 90 period prior to the filing of the bankruptcy case, whether received in one payment or in multiple payments. When the creditor has a special relationship with the debtor, such as a family member or business associate (aka an “insider”), the look back period is 1 year prior to the date the bankruptcy case is filed. As with ordinary creditors, the total amount paid to the insider during this period must be over $600 for the chapter 7 trustee to be able to avoid the transfer. Just like with a fraudulent transfer, the chapter 7 trustee, may avoid a preferential payment to recover the additional money received by the creditor and distribute the funds more equitably among the other creditors.
There are certain legal defenses to a preferential payment such when the transfer was done in the “ordinary course of business” or when the transfer was a “contemporaneous exchange” for goods or services. If the debtor regularly engaged in making such payments to the creditor, the transfer may not be avoidable as the transfer(s) were made in the ordinary course of business. Also, if the debtor made the payment directly in exchange for a good or service offered by a creditor (as opposed to paying on an old debt), such payment would likely not be avoidable. It is more likely that the trustee would be able to avoid a payment made on an old debt that is not made in the ordinary course of business. An example would be where a debtor’s father loans the debtor $2,000 a couple years before the date of the debtor’s bankruptcy filing for car repairs, and the debtor then repays the father the $2,000 out of their tax refund, a few months before filing for bankruptcy. Since the payment to the father was not something the debtor regularly did in the ordinary course of business, and was on an old debt the repayment, it would likely be considered an avoidable preferential payment.
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This is a generalized overview of avoidable transfers. The law on these types of transfers is extensive and complicated. A person considering filing for bankruptcy should first consult with an experienced bankruptcy attorney to ensure they are aware and prepared to best handle any such avoidable transfer situations and to ensure that they protect as much as their property, as possible, during the chapter 7 bankruptcy process. See us at LifeBackLaw.com!
