Some debtors who file for Chapter 7 bankruptcy try to minimize their losses by paying back preferred creditors like friends and family and transferring property that’s not likely to be protected by a bankruptcy exemption.

When this happens, the bankruptcy trustee has the legal authority to undo these transactions and claim the money and property for the benefit of any creditors with unsecured claims. This ability is known as the “clawback” provision, and it can be used under circumstances like those below.

Preferential payments

Preferential debt payments are those made to certain creditors shortly before you file for Chapter 7. For example, if you owed your best friend $800 and you repaid him before seeing a bankruptcy attorney, then this transaction will most likely be treated as a preferential payment.

In general, if you pay over $600 in total to one of your creditors within the 90-day time frame before you file your bankruptcy petition, and that money is more than they would normally have received from your bankruptcy estate, then your trustee will likely try to get it back. The law presumes that you are insolvent during this time, so the payment will be regarded as preferential.

Preferential transfers

Imagine that you have a luxury yacht that you worked hard to purchase and fit out. Unfortunately, it isn’t covered by any of your available bankruptcy exemptions, and you really don’t want to lose it, so a couple of months before you file for Chapter 7, you transfer ownership of the vessel to your brother for a lot less than it is actually worth.

This attempt to protect assets is problematic for several reasons. When insiders like family, friends, or business partners are involved, your trustee can undo transactions that are a lot older than 90 days. Secondly, this clear attempt to protect nonexempt property is considered fraudulent, giving the trustee grounds to void the transfer if it was made within two years prior to your bankruptcy filing and/or you intended to defraud your creditors.

What should you do?

If you paid an insider creditor before you paid anyone else and/or made a property transfer that a bankruptcy court might deem fraudulent, what can you do?

You may be able to overcome the clawback provision by waiting until enough time has passed since the payment or transfer. This strategy should only be used when you made the action in good faith: intentionally committing bankruptcy fraud can result in serious consequences that include denial of your Chapter 7 discharge and quite possibly a criminal investigation. To prevent such a drastic outcome, be sure to discuss them with your New York bankruptcy attorney so that you will know the best way to proceed.

Jayson Lutzky is a Bronx bankruptcy lawyer with over 36 years of legal experience. He is admitted to practice in the Southern and Eastern Districts of New York and offers free in-office initial consultations. If you are considering filing for bankruptcy, or have questions regarding personal bankruptcy, then contact Mr. Lutzky’s office at 718-329-9500 to set up an appointment.