Insider Payments Before Bankruptcy: 6 Transfers a Trustee Can Claw Back

A bankruptcy trustee can “avoid” certain payments or “transfers” that a debtor makes within a year of bankruptcy. These include payments made to insiders like the people in control, officers or directors. Depending on the circumstances, however, the trustee can go back and recover payments made within the previous two years. But this area of bankruptcy law is nuanced, and doesn’t lend itself to simple answers.

Who counts as an insider depends on the particular facts of a case, but generally, anyone in a position of control, officers and directors, plus their relatives are considered insiders. Corporations that are affiliated with the debtor are also insiders: if an entity owns 20% or more of the corporation’s stock, it’s an insider. In addition to other people and entities that are insiders, the bankruptcy code defines a managing agent of the debtor as an insider. The list is not exhaustive, and depending on particular circumstances there may be other people considered to be insiders.

Type of Transfer the Trustee Can Reverse

The first transfer is a simple repayment of an ordinary loan or other old debt that’s owed to an owner, or other insider, within the year before filing. There are two basic requirements: The debtor must have been insolvent, and the insider got more than it would have in a chapter 7 liquidation. The trustee doesn’t have to prove any kind of wrongdoing.

Another type of transfer the trustee can reverse is payments to a relative’s business or to an affiliated company, such as one that owns 20 percent or more of the debtor’s company. Again, there are several important facts in common with the first type of transfer: First, the payment must be made within one year before the bankruptcy. Second, the debtor must have been insolvent when it was made. Third, the insider must have received more than what it would have gotten in a Chapter 7 liquidation.

A third kind of transfer that a trustee can reverse is when the debtor pays down its own debt to a bank the owner has guaranteed. The result of this is that the owner’s debt decreases. If the payment was made 90 days to a year before filing, the trustee recovers from the owner, not the bank. And again, the company must have been insolvent when it paid down the debt.

Transfers with the intention to “hinder, delay or defraud a creditor” are a fourth type of transaction the trustee can reverse. The trustee can go back two years. In these cases there is no preference, or “debt repayment,” aspect. Generally, the trustee has to show that you made the transfer intending to hamper a creditor’s collection efforts. So, for example, if you transferred assets to a friend or relative, the trustee can reverse it.

A fifth type of transfer the trustee can reverse occurs when the debtor sells or gives assets to an insider for less than their “reasonably equivalent value” at a time when the debtor is insolvent, undercapitalized or unable to pay its debts. The transfer must have been made within two years before the bankruptcy. In these cases, the trustee does not have to prove an intent to hinder, delay, or defraud. The focus in this kind of case is the value received for the transferred assets.

A sixth type of transfer that is avoidable is a payment of bonuses or other compensation to an insider that is outside the ordinary course of business. These are avoidable if the debtor got less than a reasonably equivalent value for what it paid. Here the trustee doesn’t have to prove any intent.

Reachback Periods

While bankruptcy law generally covers payments made in the year before filing or, in some cases, two years, state law may reach back further. Many states adopted the Uniform Fraudulent Transfer Act or Uniform Voidable Transactions Act, allowing a four-year reachback or longer.

The law presumes insolvency for 90 days before the bankruptcy filing, but to go back further than that, the trustee must prove that the business was insolvent.

There are other limits to what a trustee can recover. If the majority of the business’ debts are not consumer debts, the trustee cannot recover preference payments totaling less than $8,575. Also, under a change in the law in 2019, before suing to recover a preference payment, the trustee must do due diligence to find out if you have a known defense.

The reachback periods discussed above are the time the trustee has to go back from the bankruptcy filing to find potentially recoverable transfers. The trustee usually must file suit for preferences and fraudulent transfers within two years from the entry of the “order for relief,” the beginning of the bankruptcy process. So the filing deadline runs forward.

You Can Raise Several Defenses

If a trustee sues to recover a preferential payment from you, you can raise several defenses. One is that you were paid at the same time as you provided something of value, such as by cash on delivery. Another is that the payment was made in the ordinary course of business. Yet another defense is that you provided the debtor some kind of “new value” after the payment that is still unpaid. You can defend against a fraudulent transfer claim by arguing that you took the transfer for value and in good faith. The majority of courts ask whether you knew or should have known of the debtor’s insolvency or fraudulent intent.

You can also contest the elements of the transfer. For example, Sam Bankman-Fried’s parents’ attorneys are arguing that the bankruptcy trustee has not shown that the FTX transfers were made with intent to hinder, delay, or defraud. The parents also claim that the trustee has not proved that the FTX business was insolvent when it made the transfers.

If you got any avoidable payment or transfer, what happens is that your claim in the bankruptcy case is disallowed until you pay that amount to the trustee. In addition to recovering money from you, a trustee can pursue anyone who received your money to get it back. That is, unless that person took it for value in good faith.

Before filing for bankruptcy, consider whether you or another insider received any avoidable transfers, and how long ago they were made. And if you’re on the board, an owner, officer or director of a business that filed bankruptcy, or you’re affiliated or somehow related to one, and you got a payment from the debtor within a year or two before it filed bankruptcy, you may be facing a lawsuit. What you need to do depends on the timing and details of the transfer. Talk to a bankruptcy lawyer to find out what your options are.