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In a bankruptcy proceeding, the Bankruptcy Code authorizes the trustee (or the debtor in possession if the case is a chapter 11) to initiate legal actions within the bankruptcy case to recover funds distributed by the debtor to entities or individuals before the bankruptcy petition was filed, when specific requirements are met. These actions are referred to as “clawback” or avoidance actions. They occur as adversary proceedings in bankruptcy court and operate as bankruptcy litigation, because they have the same nature as a lawsuit in other courts.
Sections 547 and 548 of the Bankruptcy Code authorize a bankruptcy trustee or debtor in possession to bring legal actions within a bankruptcy case to avoid or “claw back” certain transfers of money or property made by the debtor prior to the filing of the bankruptcy petition. One of the purposes of these provisions is to avoid preferential treatment of a creditor who received a transfer in advance of the bankruptcy petition at the expense of the rest of the creditors in the bankruptcy proceeding, by recovering the assets transferred in advance and making them part of the bankruptcy estate. Another purpose is to recover funds distributed for less than equivalent value, which are sometimes gifts and other times simply unauthorized distributions.
While a bankruptcy case itself is not adversarial and is not litigation, clawback (or avoidance) actions initiated under these Code sections are adversary proceedings, and are referred to as bankruptcy litigation. Bankruptcy clawback actions occur within the context of the underlying bankruptcy case but are separate legal proceedings.
Section 547 authorizes the bankruptcy trustee or debtor in possession to initiate a preference action to recover certain payments or property transfers made to an entity or individual during the 90 days immediately preceding filing of the bankruptcy petition, when specified criteria are met. (This time period is one year if the transferee was an insider of the debtor.) These payments are referred to as “preferential transfers”. The goal of the preference action is to recover the funds or property from the entity or individual who received them and include them in the bankruptcy estate distributed to creditors.
Section 548 authorizes the bankruptcy trustee or debtor in possession to initiate a fraudulent transfer action to recover money or property fraudulently transferred to an entity or individual within two years of the filing of the bankruptcy petition, or four years under some state’s laws, such as Florida’s. A transfer may be considered constructively fraudulent even in the absence of fraudulent intent, when specific criteria in the Code are met. A fraudulent transfer action is initiated to recover the assets for inclusion in the bankruptcy estate.
The bankruptcy trustee or debtor in possession initiates a clawback action by filing a complaint with the bankruptcy court. The complaint asks the court’s permission to use the statutory clawback provisions to retrieve the assets that fall within the Code’s criteria. Filing the complaint effectively involves the third party (the entity or individual who received the assets) in the bankruptcy court motion proceeding.
The clawback provisions of the Bankruptcy Code and the proceedings initiated under the sections are complex. Typically, the debtor and the third party are represented by bankruptcy litigation counsel in clawback proceedings. As an adversary proceeding, a clawback action requires different legal skills from a standard bankruptcy filing, and the bankruptcy litigation attorney in the clawback action may be a different attorney than the bankruptcy lawyer in the bankruptcy proceeding.
At Wernick Law, our experience and services include bankruptcy litigation. We represent debtors in clawback proceedings that arise during an underlying Chapter 11 bankruptcy case in which we are representing and advising the debtor. We also represent other parties, such as creditors and transferees, in bankruptcy litigation and adversary proceedings that arise in bankruptcy cases where we do not represent the debtor in the underlying bankruptcy case.
On account of the authority of the bankruptcy trustee or debtor in possession to clawback certain transfers, the trustee or debtor in possession scrutinizes a debtor’s financial reports to identify any payments — especially in large amounts — made in the period prior to the filing of the bankruptcy petition. If you are a debtor considering bankruptcy, payments you make to creditors or other parties preceding the filing of the bankruptcy petition have the potential to give rise to a clawback proceeding, if they fall within the statutory criteria.
Transfers that lead to a bankruptcy clawback action are often made completely innocently, with no intention by the debtor to deceive or be unfair to anyone. However, even unintentional violations of the clawback provisions of the Bankruptcy Code can result in a trustee or debtor in possession initiating a clawback action in a bankruptcy case.
Consulting with a knowledgeable bankruptcy attorney before making the decision to file a bankruptcy petition is the best way to avoid the occurrence of clawback actions in a bankruptcy case. Full disclosure to the lawyer of all recent money or asset transfers is essential to preventing a preference action or fraudulent transfer action in a bankruptcy case.
At Wernick Law, we concentrate the majority of our practice on Chapter 11 debtor representation. Complex bankruptcy attorney Aaron Wernick is certified in business and consumer bankruptcy law by the American Board of Certification and recognized as a top bankruptcy lawyer by Chambers, Super Lawyers®, and Avvo. Attorney Hayley Harrison is recognized as a top bankruptcy lawyer by Chambers, Super Lawyers, the American Bankruptcy Institute and Florida Trend.
Wernick Law welcomes Florida businesses, individuals, and referring professionals wishing to learn more about the firm’s Chapter 11 reorganization bankruptcy practice or requiring assistance with adversary proceedings in a bankruptcy case to schedule a consultation by calling 561-961-0922 or using the online contact form. Based in Boca Raton, Wernick Law serves clients in South Florida (including West Palm Beach, Broward County, and Miami), Southwestern Florida (including Naples and Fort Myers), Tampa, Orlando, Jacksonville, and elsewhere in the state.
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