In this article, we will explain the Clawback Provision and preferential transfers in Chapter 7 bankruptcy. The questions answered include:
In Chapter 7 bankruptcy all of the debtor’s (the person filing for bankruptcy) dischargeable debt will be wiped out. All the debtor’s financial information will be collected over the last 6 months—sometimes up to a year—and the bankruptcy trustee (the individual assigned to oversee the bankruptcy process) will attempt to liquefy all nonexempt assets to settle debt with creditors. Most individuals filing for Chapter 7 bankruptcy won’t have much in the way of non-exempt assets, otherwise they will likely be considering Chapter 13 bankruptcy. For more foundational information on Chapter 7 bankruptcy and the difference between Chapter 7 and Chapter 13 check out the articles, Chapter 7 Bankruptcy Process Explained and Chapter 7 Vs Chapter 13 Bankruptcy, respectively.
Generally, a clawback provision is a contractual provision that allows one individual or entity to have the money returned to them that was paid to another individual or entity. In business, it is often used in the financial industry to allow companies to get money back from employees based on a number of factors, including performance related to bonus structure, breach of contract, etc.
In Chapter 7 bankruptcy, the trustee has the power to take back property transferred or money paid or given away improperly prior to filing for bankruptcy. This action by the trustee is referred to as a “Clawback” and allows the trustee to take back assets that should have been included in the debtor’s bankruptcy estate, but were removed, hidden or transferred preferentially, fraudulently or otherwise before filing for bankruptcy.
What is Included in the Debtor’s Bankruptcy Estate For Chapter 7 Bankruptcy?
As soon as the debtor signs all the bankruptcy paperwork and the automatic stay goes into effect, everything the debtor owns or will receive (such as a still incoming paycheck or inheritance) becomes part of the bankruptcy estate. However, the debtor will get to keep more than just the clothes on his back. Illinois and federal bankruptcy law include a number of exemptions that allow the debtor to continue to function as a productive member of society. These exemptions typically allow the individual to keep some equity in a car, home, furnishings, clothing, jewelry, etc. For more information check out What Can I Protect Under Illinois Bankruptcy Laws?
A preferential transfer occurs when, prior to filing Chapter 7 bankruptcy, the debtor pays off a particular creditor or group of creditors. This explanation may seem strange at first as the goal of bankruptcy is to pay back your creditors, but paying only one or a select few creditors prior to bankruptcy shows “preference.” Many times this arises when the debtor wants to pay back a relative first or a business she has been going to for a long period and has a relationship with, such as a family physician. This shields the money from the rest of the creditors, resulting in the pool of creditors getting less during the bankruptcy. The trustee does not differentiate between transfers or payments made in good faith and transfers made fraudulently. However, fraudulent transfers will likely come with their own legal repercussions.
The good news is debtors don’t have to panic worrying about if the money they gave to their cousin Jim two years ago will be considered a preferential transfer. Only transfers made within a certain time period leading up to filing Chapter 7 bankruptcy will be considered preference. A preferential transfer subject to clawback will typically fall into one of two categories:
Unfortunately, the only way to completely avoid a clawback is not to make a preferential payment in the above-listed time-frames. It’s not guaranteed that the bankruptcy trustee will petition the court for a clawback if a preferential transfer if found during the evaluation phase; the trustee may feel it’s not worth the effort to attempt to retrieve the money or the transfer may have been made to a creditor who has priority over the other creditors.
The most important action you can take prior to bankruptcy is locating an experienced bankruptcy attorney. They will guide you through the bankruptcy process, determine which type of bankruptcy is right for you, maximize your exemptions, and help you get the most out of filing bankruptcy. If you’re considering filing for bankruptcy don’t hesitate to give us a call at 630-324-6666 and speak with one of our experienced attorneys.
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