Words that you might hear from your bankruptcy attorney are fraudulent transfer, preference or preferential payment, and clawbacks. What are these and, more importantly, should you be concerned?
First, what are they? They are related terms that have to do with payments a debtor might have made during a certain time period prior to filing bankruptcy. If a debtor makes payments on an outstanding debt, those payments might be classified as either preferential payments or fraudulent transfers. If they are, the payments are subject to being recovered from the person receiving the payment. The act of recovering the payment by the trustee is known as a “clawback,” a descriptive term from which you can envision the trustee reaching out and clawing the money back from the creditor.
Preferential payments or preferences, and fraudulent transfers are closely related. Any payment to a creditor within 90 days of filing bankruptcy can be considered preferential, as it prefers the creditor to whom it was made over all other creditors who didn’t get a payment. The theory of the Bankruptcy Code is that all creditors are treated fairly. If one creditor gets a payment and others don’t, the creditors who received nothing have not been treated fairly. So the Bankruptcy Code allows the trustee to recover the payment (claw it back) from the creditor who was preferred, and use that money to make a payment to all creditors, thus treating all creditors fairly (though not necessarily equally).
If a payment was made more than 90 days prior to filing, it is still possible to claw back that payment using the fraudulent transfer statute. The fraudulent transfer statute says that a payment, or any transfer of property by one person to another person can be set aside if the person receiving the property did not give equivalent value for the property received. Here’s how it works. Suppose the debtor owes a creditor for goods purchased a year ago. More than 90 days prior to filing bankruptcy but still several months after the goods were delivered, the debtor makes a payment to the creditor. The fraudulent transfer statute says that not only must the property (money paid) to the creditor be of equivalent value for what was received (the goods), the payment also has to represent a contemporaneous (at the same time) exchange. Since the property was delivered several months ago, the payment isn’t contemporaneous, though it might be of equivalent value. So that late payment might be subject to claw back as a fraudulent transfer.
The other time fraudulent transfers come into question is where the debtor sells something for far below market value. Sometimes a debtor will “sell” his boat or other item to a friend or relative for $25 or other minimal price. Even though the transfer of the boat title and payment of the cash are contemporaneous, they aren’t equivalent; the boat is worth far more than $25.
So, why should you care? If you make a payment to a creditor that is preferential or a fraudulent transfer, and the creditor has to give back the money, they aren’t going to be happy about it. Maybe you don’t care. If the creditor is a credit card company or large institution, you don’t care what they think of you. But if it’s your dentist, hair stylist, the vet, or someone you know personally, you’re probably better off not paying them just before you file, and going in after the fact to make things good. Also, if you sell your boat to your brother just so you can say you don’t have it when you file, both you and your brother are going to be having problems. You’ll have the bigger problem because what you did could be bankruptcy fraud and land you in prison.
If you’re considering filing bankruptcy, speak with an attorney before paying any creditors. If you have questions, contact us.