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Preferences and Fraudulent Transfers (Clawback)

The trustee's power to undo payments and transfers made before a bankruptcy was filed - a repayment to a relative, a property signed over to a family member, a creditor paid ahead of the others - and why "I paid my brother back first" is a problem rather than a virtue.

Informational only - this is not legal advice. These definitions explain general legal vocabulary in plain English. They are not advice about your situation, reading them creates no attorney-client relationship, and the law differs from state to state and changes over time. For advice you can rely on, speak to a lawyer licensed in your state.

What it means

Bankruptcy distributes what the debtor has according to a fixed order of priority, and the Code lets the trustee reach back before the filing to recover property that left the estate in ways that defeat that order. The first is the preference: a payment or transfer of the debtor's property to a creditor, on account of an existing debt, made while the debtor was insolvent within a period before filing fixed by statute - a longer period if the creditor is an insider such as a relative or business partner - that gives the creditor more than it would receive in the bankruptcy. The trustee may recover it from the creditor and distribute it to everyone. The debtor's good faith is irrelevant; the point is equality among creditors, not punishment.

Preference law has exceptions that protect ordinary commerce: a substantially contemporaneous exchange for new value, payments made in the ordinary course of business on ordinary terms, purchase-money security interests perfected promptly, and small transfers below a threshold the statute sets differently for consumer and business cases. Regular mortgage and car payments are typically protected by the ordinary-course exception; a lump-sum repayment to a parent shortly before filing is not, and the trustee will ask the parent to return it.

The second power is the fraudulent transfer: a transfer made within a look-back period, also fixed by statute, either with actual intent to hinder, delay or defraud creditors, or for less than reasonably equivalent value while the debtor was insolvent. Signing a house or car over to a relative for nothing, or selling it for far below its worth, falls squarely within it, and the trustee may recover the property from the transferee. The trustee may also use the state's own fraudulent-transfer law, which often carries a longer look-back. A transfer made with actual intent can also cost the debtor the discharge itself.

Where this comes from

Preferences are 11 U.S.C. § 547, with the elements at § 547(b), the exceptions at § 547(c) and the insolvency presumption at § 547(f); "insider" is defined at § 101(31). Fraudulent transfers are § 548, with the trustee's power to invoke state law under § 544(b) and the Uniform Voidable Transactions Act (formerly the Uniform Fraudulent Transfer Act) as enacted in each state. Recovery from the transferee is § 550, and the defence for a good-faith transferee for value at § 550(b). The denial of discharge for a transfer with intent to defraud is § 727(a)(2). Union Bank v. Wolas, 502 U.S. 151 (1991), construes the ordinary-course exception; Merit Management Group v. FTI Consulting, 583 U.S. 366 (2018), the securities safe harbour. The look-back periods and the small-transfer thresholds are set in §§ 547 and 548 and are not stated here.

When people hire a lawyer for this

The transfers that cause trouble are almost always made in good faith by people who did not know the rule, and every one of them is visible on the bank statements the trustee will read - which is why the first conversation with a bankruptcy lawyer covers every payment to a relative and every change of title in the recent past, so that the filing can be timed for after the look-back has run or the transfer can be explained. A relative who has received a trustee's demand letter should get advice rather than ignore it; the trustee can sue, and the good-faith defence depends on facts the relative will have to prove.

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Part of the LawyerLand plain-English legal glossary. Definitions are written from primary sources - statutes and court rules - and each entry states the authority it rests on, or says plainly when the doctrine is state law with no national rule.

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