Previous Actions Affecting Bankruptcy

The existence of bankruptcy laws provides an exceptional opportunity to the honest consumer who has fallen on hard financial times. Often, consumers find themselves with no hope of repaying debt after an expensive medical procedure or loss of employment. Chapters 7 and 13 of the Bankruptcy Code allow such debtors to receive a financial fresh start or reorganize their financial affairs in order to keep secured assets such as their home. In many cases, individuals use this opportunity to regain their financial footing and begin making positive contributions to the economy once again. However, along with the benefits of having a bankruptcy system comes the risk that dishonest consumers will abuse the system. For this reason, the Bankruptcy Code has several safeguards in place.

The United States Trustee Program is a component of the Department of Justice that seeks to promote the efficiency and protect the integrity of the Federal bankruptcy system. In Chapter 7 cases, a private trustee is appointed to administer the debtor’s estate under 11 U.S.C §701. In Chapter 13 cases, a “standing trustee” is typically appointed under 28 U.S.C. §586(b). This article will address the periods of time within which a trustee may “avoid” or undo certain transfers of property made by a debtor in a bankruptcy case.

Six Years Under New York Law
Under 11 U.S.C. 544(b)(1), the trustee “may avoid any transfer of an interest of the debtor in property or any obligation incurred by the debtor that is voidable under applicable law by a creditor holding an unsecured claim…” This gives the trustee the power to step into the shoes of an unsecured creditor and avoid a transfer under the applicable state law. Under §278 of New York’s Debtor and Creditor Law (“fraudulent conveyances”) a creditor can have a “fraudulent conveyance set aside or obligation annulled to the extent necessary to satisfy his claim” except when the property has been conveyed to a purchaser for fair consideration without knowledge of the fraud at the time of the purchase. Applying New York’s Civil Practice Laws and Rules Sections 203 (“Method of computing periods of limitations generally”) and 213 (“Actions to be commenced within six years”) and Article 10 of New York’s Debtor and Creditor Law (“Fraudulent conveyances”), an action to avoid a transfer upon the ground of constructive fraud (fraud implied in law when there was no fraudulent intent) must be commenced within six years from the commission of a fraudulent act. In the case of actual fraud, when the six year limitations period has expired, an action to avoid a transfer must be commenced within two years of the date the plaintiff discovers, or could have in the exercise of reasonable diligence discovered, the fraudulent act. Therefore, a trustee in a New York bankruptcy case may avoid a transfer on the ground of constructive fraud, which occurred up to six years prior to the interposition of the trustee’s claim. If the trustee seeks to void a transfer on the ground of actual fraud and the six-year limitation has expired, he or she may still be able to avoid the transfer within two years of discovering it or being able to discover it with reasonable diligence.

One Year for Preferences
Section 547 of the Bankruptcy Code addresses “preferences,” or transfers which treat one creditor more favorably than others. It provides that the trustee may avoid any transfer of an interest of the debtor’s property that enables a creditor to receive more than it otherwise would have in a Chapter 7 case if the transfer was “made (A) on or within 90 days before the date of the filing of the petition; or (B) between ninety days and one year before the date of the filing of the petition, if such creditor at the time of such transfer was an insider….”1 In regard to individual debtors, the term “insider” includes relatives, general partners, a partnership in which the debtor is a general partner, and a corporation of which the debtor is a director, officer, or person in control.2

Two Years for Fraudulent Transfers and Obligations
Another portion of the Bankruptcy Code specifically addresses fraudulent transfers. Section 548 provides that a trustee may avoid any transfer of property made or any obligation incurred by the debtor within two years of the date of filing the bankruptcy petition in the following situations. First, if the transaction was made with the actual intent to hinder, delay, or defraud a creditor. Second, if the debtor received less than a reasonably equivalent value in exchange for the transfer or obligation incurred and the debtor was insolvent at the time or became insolvent as a result of the transaction; the debtor was engaged in business or a transaction for which any property remaining with the debtor was an unreasonably small capital; the debtor intended or believed the debts incurred would be beyond the debtor’s ability to pay as such debt matured; or the debtor made the transfer or incurred the obligation for the benefit of an insider.3

As set forth above, depending on the type of transfer made or obligation incurred by a debtor the period of time during which a trustee in a bankruptcy case may avoid the transaction varies. It could be as little as 90 days if the transfer is a preference to a non-insider.4 However, it could be longer than six years if the trustee steps into the shoes of an unsecured creditor who can avoid a transaction under New York fraudulent conveyance law.5 It is essential that the attorney evaluating a potential bankruptcy case inquire about transfers made or obligations incurred by the debtor that could be classified as one of the types discussed in this article. It is also important to impress upon the debtor the importance of disclosing any such transactions prior to filing so that they are not a surprise to the attorney when later discovered by the trustee.

Paul Devlin is the founder of Law Offices of Paul Devlin PC. His practice focuses on representing consumer debtors in bankruptcy and his Melville office serves both Nassau and Suffolk County. Questions about this article can be emailed to paul@pdevlinlaw.com.

1. 11 U.S.C. §547(b)(4).
2. See 11 U.S.C. §101(31)(A).
3. See 11 U.S.C. §548(a)(1).
4. See 11 U.S.C. §547(b)(4)(A).
5. See 11 U.S.C. §544(b)(1) and C.P.L.R. §213(8).