Bankruptcy Avoidance Actions: Preferences, Fraudulent Transfers, and Deadlines

Bankruptcy avoidance actions are lawsuits a bankruptcy trustee files to claw back money or property that left the debtor’s hands through transfers that treated creditors unfairly. The practical effect is simple and often unwelcome: a creditor who was paid, or a relative who received a gift or a cheap sale, may have to return it so the money can be shared among everyone the debtor owes. These actions reach backward in time, sometimes by months and sometimes by years, and they come in several distinct types with different rules, defenses, and deadlines.

Who Can Bring These Lawsuits

In most bankruptcy cases, the appointed trustee is the one investigating transfers and filing avoidance suits. Chapter 11 is the main exception. A trustee is rarely appointed in a Chapter 11 reorganization. The debtor stays in control as a “debtor in possession” and holds nearly all of a trustee’s powers, including the power to sue over past transfers.¹ That means a reorganizing company may sue its own former vendors or business partners to recover payments made before filing.

Preferential Transfers

A preferential transfer is a payment that let one creditor jump ahead of the others in line. Five conditions must all be met: the payment went to a creditor, it covered a debt that already existed, the debtor was insolvent at the time, the payment let that creditor collect more than it would have received in a Chapter 7 liquidation, and the transfer happened within 90 days before the filing. The 90-day window stretches to one full year if the recipient was an insider such as a family member, business partner, or corporate officer.²

The law also presumes the debtor was insolvent throughout that 90-day window, so the trustee doesn’t have to prove it. The recipient can try to rebut the presumption, but the burden shifts to them.²

Dollar Floors

Small payments are off-limits. If the debtor’s obligations are primarily consumer debts, transfers totaling less than $600 cannot be avoided. For business debtors, the threshold is $8,575, as adjusted effective April 1, 2025. The Judicial Conference adjusts these figures periodically.³

Defenses

Receiving a preference demand letter is alarming, but the statute protects legitimate transactions. The most useful defenses:

Ordinary course of business. A payment is safe if it was made on a debt incurred in the normal operations of both sides, and the payment itself was either consistent with how the two parties typically dealt with each other or consistent with standard industry practices. A vendor paid on its usual 30-day invoice cycle has a strong argument. Only one of the two tests needs to be met.³
Contemporaneous exchange. If both sides intended the transaction to be a simultaneous swap of roughly equal value, and it substantially was, the transfer stands. Cash-on-delivery sales are the classic example.
New value. A creditor paid during the preference window who then extended new goods, services, or credit after the payment can offset the preference by the amount of new value given. The defense rewards creditors who kept doing business with the debtor instead of cutting them off.
Purchase money security interest. A lender financing a specific acquisition is protected if the security interest was perfected within 30 days of the debtor receiving the property.
Domestic support obligations. Payments toward alimony, child support, or similar obligations cannot be avoided as preferences.

Fraudulent Transfers

Fraudulent transfer law targets a different problem. Instead of one creditor cutting the line, the concern is that value left the estate entirely. There are two kinds.

Actual fraud requires proof that the debtor transferred property with the goal of putting it out of creditors’ reach. Confessions are rare, so courts look at circumstantial signs: transfers to family for little or no payment, transactions timed to mounting debts, or assets layered through shell entities.⁴

Constructive fraud requires no bad intent. It applies when the debtor transferred property for significantly less than it was worth, and the debtor was either insolvent at the time of the transfer or became insolvent because of it. A debtor who sells a $200,000 property to a cousin for $20,000 while buried in debt is exposed on these grounds without any scheme at all. The lopsided exchange combined with insolvency is enough.

Under the federal Bankruptcy Code, the look-back for both kinds of fraudulent transfer is two years before the filing date.⁴ That window is often just a starting point.

How the Look-Back Can Stretch Much Further

A separate provision lets the trustee step into the shoes of any actual unsecured creditor in the case and use whatever rights that creditor would have had under state law.⁵ Most states have adopted a version of the Uniform Voidable Transactions Act, which generally allows fraudulent transfer claims going back four years. The trustee picks the creditor and the law that reach the farthest.

The reach grows further when a federal agency is a creditor. Because the federal government is generally not bound by state statutes of limitations, a trustee stepping into the shoes of the IRS may use the ten-year federal tax collection period to attack transfers that no state-law claim could still reach. Courts have broadly accepted this approach, so transfers from many years back can still be in play when the IRS or another federal agency holds a claim.

The same section gives the trustee one more weapon, often called the strong arm clause: the status of a hypothetical creditor who obtained a judicial lien on all the debtor’s property on the day the petition was filed. The practical use is against lenders with unperfected security interests. If a lender took collateral but never filed the right paperwork under state recording laws, the trustee’s hypothetical lien beats the unperfected interest, and the property moves into the general pool for unsecured creditors. Sloppy paperwork costs secured lenders more often than you’d expect.

Transfers After the Petition Is Filed

A separate rule covers what happens after filing. Any transfer of estate property made after the petition is voidable unless the court authorized it or the Code specifically permits it.⁶ A debtor who sells off equipment or drains an account while the case is pending can have those transactions reversed. The estate belongs to the creditors collectively from the moment of filing, and courts have little patience for moving assets without approval.

How Long the Trustee Has to Sue

The trustee cannot sit on these powers. An avoidance action must be filed by the earlier of two years after the order for relief or the date the case is closed or dismissed. One extension is built in: if the first trustee isn’t appointed or elected until later in the case, the deadline becomes one year after that appointment, but only if the appointment itself happens before the original two years run out.⁷

For a recipient worried about clawback, the clock starts on the date the court enters the order for relief, which in a voluntary case is the day the petition is filed. Once that window closes with no suit filed, you’re in the clear.

Recovery and Good Faith Protections

Winning the avoidance ruling is only half the work. The trustee still has to recover the property or its cash value, and the Code allows recovery either from the initial recipient or from anyone that recipient passed the property to.⁸ The trustee pursues this as an adversary proceeding, essentially a lawsuit filed inside the bankruptcy case with a complaint, discovery, and potentially a trial.⁹

Not every recipient has to hand property back. For fraudulent transfers, a transferee who took property in good faith and gave value in exchange can keep the property up to the amount of value given.⁴ Good faith is measured objectively. If the surrounding circumstances would have made a reasonable person suspicious enough to ask questions, and asking those questions would have uncovered the fraud, the defense fails. The transferee carries the burden of proving good faith.

A similar shield protects downstream recipients. If the initial transferee passed the property to a third party, the trustee cannot recover from that third party if the third party gave value, acted in good faith, and had no knowledge that the original transfer was voidable.¹⁰ The initial recipient has no such protection and remains fully liable for returning the property or its value, regardless of good faith.

1
Office of the Law Revision Counsel. 11 USC 1107 – Rights, Powers, and Duties of Debtor in Possession
2
Office of the Law Revision Counsel. 11 USC 547 – Preferences
3
Office of the Law Revision Counsel. 11 US Code 547 – Preferences
4
Office of the Law Revision Counsel. 11 USC 548 – Fraudulent Transfers and Obligations
5
Office of the Law Revision Counsel. 11 USC 544 – Trustee as Lien Creditor and as Successor to Certain Creditors and Purchasers
6
Office of the Law Revision Counsel. 11 USC 549 – Postpetition Transactions
7
Office of the Law Revision Counsel. 11 USC 546 – Limitations on Avoiding Powers
8
Office of the Law Revision Counsel. 11 USC 550 – Liability of Transferee of Avoided Transfer
9
Legal Information Institute. Federal Rules of Bankruptcy Procedure Rule 7001 – Types of Adversary Proceedings
10
Office of the Law Revision Counsel. 11 US Code 550 – Liability of Transferee of Avoided Transfer