When you file for bankruptcy, a court-appointed trustee oversees the process to make sure that both you and your creditors are fairly treated.
To that end, bankruptcy trustees are given a tremendous amount of authority – and one of the key tools at their disposal is “clawback” power. This is the trustee’s ability to reclaim (or “claw back”) money or property that was transferred out of a debtor’s estate before the bankruptcy was even filed.
The idea is to prevent a debtor from favoring certain creditors over another or cheating the bankruptcy system by transferring certain assets to friends or family members until their bankruptcy is over.
How clawback power is used
Generally speaking, a trustee will only exert their clawback powers when they believe that a transfer of assets was either fraudulent or preferential. Here are some examples of when that might happen:
- A couple of months before you file for bankruptcy, you repay your parents for the $20,000 loan they gave you to launch your home-based business. This would be considered a preferential transfer, even though you felt a moral obligation over that particular debt.
- You realize that you’re going to lose your second home in your bankruptcy, so you decide to sell it to your brother below market value. You’d rather keep the home in the family than see it sold at auction. Even though you didn’t intend to buy the property back later, that would still be considered a fraudulent transfer.
- You’re stressed out by a particular creditor, who is very aggressive. You finally give them several thousand dollars to settle the debt just weeks before you realize your financial situation is hopeless and file for bankruptcy. Again, despite your honest intentions, that would be considered a preferential transfer.
In all these examples, the trustee could force the money or assets to be returned – which could be devastating to some of your personal connections. That makes it critically important to seek sound legal guidance early in the bankruptcy process.