One of the most important powers a Chapter 7 bankruptcy trustee has is the ability to set aside or void certain transfers of property or payments of money. The trustee uses this power to recover money that can be distributed to all the debtor’s unsecured creditors. The two general situations where a trustee can set aside a transfer or payment are where the debtor sells or gives away property for less than its fair market value or where the debtor pays a creditor more than the creditor would receive in bankruptcy.
The trustee can recover money paid to creditors determined to be “preferential” because the money is more than the creditor would otherwise receive. For example, if a debtor repays money owed to a family member within one year prior to filing bankruptcy, the trustee can seek to have that money repaid. The debtor can’t “prefer” the family member over all other creditors. These preferential payments have often tripped up debtors wanting to repay family members before filing bankruptcy. These payments to family members instead either force a delay in filing bankruptcy or create headaches for both the debtor and the family member because the trustee expects the money to be returned. If money was paid to any other creditor not considered an “insider,” the trustee can recover any money paid within 90 days of filing bankruptcy. Payments made to credit card companies, medical providers or others within 90 days of filing might get recovered by the trustee.
There are some instances where creditors, including family members, wouldn’t have to return money. For example, if the money paid by the debtor was in the ordinary course of their business or if the money was paid contemporaneously with the debt being created, the creditor might have a defense to the trustee’s effort to recover the money. There are also times when Debtors can use these avoidance powers for their benefit. For example, creditors who garnish wages prior to a bankruptcy may have to return the funds to the debtor after the bankruptcy is filed.
Trustees can also recover property sold for less than fair market value or given away by Debtors prior to filing bankruptcy. After recovering the property the trustee can have it sold and distributed among all creditors equally.
Because of the powers of a bankruptcy trustee to set aside payments and transfers it’s best for debtors to not make any voluntary payments to creditors, especially family members, or transfer any property without first talking to their bankruptcy attorney.