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Avoidance Powers in Bankruptcy

Bankruptcy serves to preserve estate property for both the debtor (who files for bankruptcy) and the creditors (who the debtor owes money) to the extent that is fair and possible. Once a bankruptcy is complete, the creditors should receive what they could have received if the estate had been liquidated (which is sometimes nothing) and the debtor in turn gets a fresh financial start.

The bankruptcy trustee (or administrator, as it is called in North Carolina) is a neutral third party approved by the courts to oversee the bankruptcy. The trustee investigates the filer’s claimed financial situation and oversees the liquidation or reorganization of their estate. The trustee acts as a sort of agent for the debtor and the creditors, balancing the interests of both and helping ensure neither engages in fraudulent conduct in the bankruptcy.

Included in the trustee’s purview of administering a bankruptcy are so-called avoidance powers that allow them to “avoid,” or essentially nullify, certain transactions that the debtor engaged in before filing for bankruptcy. This is usually to the benefit of creditors. In certain circumstances, however, the debtor can invoke these powers to his or her benefit.

For clarity’s sake, some necessary terms to understanding how avoidance powers could affect your bankruptcy case are below.

  • A “lien” is the right of a creditor to keep possession of a piece of your property until you pay or discharge the debt that you owe them.
  • In order for a lien to be perfected, the creditor must properly file it with the correct legal authority. If the creditor has not properly filed the lien it is an unperfected lien. State statutes cover the applicable filing process for a lien in each state.
Avoidance Powers, Generally

Avoidance powers allow the party invoking them, usually the trustee on behalf of creditors, to void certain transactions that the debtor made before filing for bankruptcy. With the exception of fraudulent transfers, these voidable transactions involve dealings that would otherwise have been legal (as between the debtor and the transferee). Some examples of transactions that can be avoided during bankruptcy are below.

  • Transferred property avoidance: In certain circumstances, trustees can avoid a transfer of the debtor’s property that occurred within 90 days of the bankruptcy filing (or 120 days if the property transfer was to an “insider” such as a friend, family member or business partner).

  • Fraudulent transfer avoidance: Trustees can avoid transfers of property that are found to be fraudulent (i.e., the debtor intentionally intended to defraud/hide assets) and occurred within two years of the bankruptcy filing.

  • Unperfected lien avoidance: The trustee can avoid a lien taken out on the debtor’s property if it was not properly perfected by the time the debtor filed for bankruptcy, or if the lien went into effect upon the bankruptcy filing or when the debtor’s financial conditions fell below a specified standard.

    • However, just because the trustee avoids an unperfected lien does not necessarily protect the property that had the lien on it from the bankruptcy. The trustee can then liquidate the property and use the proceeds towards paying all of your unsecured creditors (creditors that do not have any collateral from you).

In some circumstances, the debtor has the right to use avoidance powers to further preserve their estate.

When Can the Debtor Use the Trustee’s Avoidance Powers?

Several provisions of the bankruptcy code delineate circumstances under which a debtor can use avoidance powers, particularly in reorganization bankruptcies (Chapter 13 for individuals and Chapter 11 for businesses). There are several provisions of the bankruptcy code that permit a debtor to invoke these powers, such as when a property transfer or lien creation is involuntary, the trustee does not attempt to avoid the lien or transfer, and the transfer or lien affects the debtor’s exempt property.

What does any of that mean? It could mean if the mortgagee did not properly perfect its lien against the debtor’s home (to the extent that the home is exempt under federal or state law) before a debtor files for bankruptcy, the debtor may be able to avoid the lien altogether. If a credit union empties the debtor’s bank account within 90 days of the debtor’s filing for bankruptcy, the debtor may be able to avoid the money transfer and recover the funds to the extent they are exempt.

If you are contemplating filing for bankruptcy, it is important to speak with an experienced bankruptcy attorney who can help guide you through the complicated process. Contact Arnold & Smith, PLLC to schedule an initial consultation with one of our bankruptcy attorneys about the specific needs of your individual case today.