Fraudulent Transfers & Preferences in Insolvency: Clawbacks and Defenses

Bankruptcy clawbacks are the trustee’s power to reverse certain transactions a debtor made before filing and pull the money or property back into the estate so all creditors share it. Federal law targets two categories: fraudulent transfers, where the debtor moved assets to cheat creditors or sold them for far less than they were worth, and preferential payments, where one creditor got paid ahead of the others shortly before filing. The look-back runs from 90 days for ordinary preferences to two years or more for fraudulent transfers.¹

The Two Transactions a Trustee Can Reverse

Fraudulent transfers and preferences sound similar but work differently. One targets what the debtor was trying to do with their assets; the other targets who got paid first.

Fraudulent Transfers

A fraudulent transfer is any movement of the debtor’s property that unfairly shrinks the pool available to creditors. The statute recognizes two flavors.

Actual fraud is about motive. If the debtor moved property with the goal of putting it beyond creditors’ reach, the transfer can be reversed regardless of what the debtor received in return. Courts rarely get a signed confession, so they look for circumstantial red flags — often called “badges of fraud.” Classic examples include transferring a house to a spouse for no payment, keeping control of an asset after supposedly giving it away, moving property right after a big lawsuit was filed, or shuffling assets through a chain of transactions designed to obscure ownership.¹ No single badge is enough, but stack a few together and courts draw the obvious conclusion.

Constructive fraud has nothing to do with the debtor’s intentions. It targets transactions where the economics do not add up. If the debtor gave property away or sold it for a fraction of its value, and was insolvent at the time or became insolvent because of the transfer, the trustee can claw it back.¹ Selling a $300,000 piece of equipment to a friend for $50,000 qualifies even if neither party was thinking about creditors. The same applies when a transfer left the debtor operating with dangerously thin resources, or when the debtor expected to take on debts they could not pay.

Preferential Payments

Preferences are fundamentally different because the underlying debt is real and the payment is legitimate. The problem is timing. When a debtor pays one creditor in full right before filing, that creditor walks away whole while everyone else fights over a smaller pot. The preference rules unwind that advantage and restore equal treatment. Intent plays no role. A creditor who had no idea the debtor was struggling can still be forced to return the payment. Even a debtor who genuinely wanted to protect a particular supplier by paying them first has created a reversible preference.

How Far Back the Trustee Can Reach

Every clawback is bounded by a specific window measured backward from the filing date.

For preferences, the standard look-back is 90 days. For insiders — a category that includes relatives, business partners, officers, and corporate affiliates — the window stretches to a full year.² The extended period reflects the reality that insiders often see trouble coming long before outside creditors do.

For fraudulent transfers, federal bankruptcy law reaches back two years.¹ But state law often provides a longer runway. Most states have adopted some version of the Uniform Voidable Transactions Act, which generally allows challenges within four years of the transfer, plus a one-year discovery rule for transfers that weren’t immediately apparent. The trustee can step into the shoes of a state-law creditor and use those longer deadlines, so a transfer that looks safely outside the federal two-year window may still be vulnerable.

The trustee also has a deadline of their own. An avoidance action must be filed by the earlier of two years after the order for relief (usually the filing date) or whenever the case closes or is dismissed. If a new trustee is appointed later, the deadline extends to one year after that appointment, provided it happens before the original two-year clock runs out.³ Miss those deadlines and the power to reverse that transfer is gone.

When a Payment Counts as a Preference

Federal law requires all five of the following to be present before the trustee can recover a payment as a preference:

The transfer went to a creditor, or was made for a creditor’s benefit.
It paid down a debt that already existed before the transfer.
The debtor was insolvent when the payment was made. Insolvency is presumed during the 90 days before filing, so the trustee doesn’t have to independently prove it for that window.²
It occurred within 90 days of filing, or within one year for an insider.
The creditor received more than they would have gotten in a Chapter 7 liquidation.

That last element is where many preference claims live or die. A fully secured creditor would have been paid in full during liquidation anyway, so the pre-filing payment did not give them a better result. Unsecured creditors, who typically receive cents on the dollar in Chapter 7, are the ones most exposed.

Defenses a Creditor Can Raise

A clawback demand letter is alarming, but it is not an automatic loss. The Bankruptcy Code gives creditors several defenses, and the burden of proving them falls on the creditor rather than the trustee.²

Ordinary Course of Business

Payments made on the normal schedule, in the normal way, for the normal type of debt are shielded. A supplier who was always paid on net-30 terms and continued receiving payments on that schedule during the preference period has a strong defense. The creditor only needs to show one of two things: that the payment was consistent with how these two parties had always done business, or that it was in line with standard practices in the industry. Since 2005, either prong is enough.

Contemporaneous Exchange

If both parties intended the transaction to be a swap of roughly equal value at roughly the same time, and it actually was, the transfer is protected. A debtor who hands a supplier a check at the loading dock in exchange for a delivery is engaging in a contemporaneous exchange, not paying down old debt. Backdating a check or dressing up a past-due payment as “contemporaneous” won’t hold up.

Subsequent New Value

If a creditor received a potentially preferential payment but then shipped more goods or provided additional services to the debtor before the filing, the new value offsets the preference. Receive $50,000 in the preference window, then deliver $40,000 in additional inventory, and the exposure drops to $10,000. The new value must be actual goods, services, or credit; simply agreeing not to collect an old debt does not count.

Good Faith Transferee

For fraudulent transfer claims specifically, a transferee who paid fair value and acted in good faith can keep the property (or retain a lien on it) up to the amount they actually paid.⁴ An innocent buyer who picked up equipment at a genuine auction for market price is not going to lose it, even if the seller was insolvent at the time.

Transfers and Payments That Are Protected

Several categories of transfers sit outside clawback reach entirely.

Charitable and religious donations. Contributions generally cannot be challenged as constructive fraud if the amount does not exceed 15 percent of the debtor’s gross annual income for the year of the gift. Even donations above that threshold are protected if giving at that level matched the debtor’s established pattern.¹ Congress added this specifically so regular tithing and charitable giving would not be swept into clawback litigation.

Small-dollar transfers. In cases where the debtor’s obligations are primarily business debts, the trustee cannot pursue a preference recovery unless the total value of the transferred property is at least $8,575 (as adjusted in 2025), a figure that updates for inflation every three years.⁵ For individual consumer debtors, a separate and much lower statutory floor applies, with a base amount of $600 that is also subject to periodic adjustment.²

Securities and financial market transactions. Settlement payments and margin payments made through securities exchanges, financial institutions, and similar intermediaries generally cannot be clawed back.³ Congress built this safe harbor to prevent a single bankruptcy from triggering a chain reaction across financial markets. Courts remain divided on whether the safe harbor covers payments to former shareholders in private leveraged buyouts, but it unquestionably protects routine securities trades and clearing transactions.

What Happens If the Trustee Wins

Clawback actions are not handled through simple motions. The trustee has to file an adversary proceeding, which is essentially a lawsuit inside the bankruptcy case, complete with a complaint, answer, discovery, and potentially a trial.⁶ In practice, many preference actions settle before trial because the litigation costs would dwarf the recovery. Trustees know this and often send demand letters offering to settle for a percentage of the claimed preference. Whether to accept or fight depends on how strong the defenses are.

Once a transfer is avoided, the trustee can recover the property or its value from the person who initially received it, from anyone who benefited from the transfer, or from a subsequent transferee further down the chain.⁷ That matters when the debtor routed funds through an intermediary rather than paying a creditor directly. Subsequent transferees who took for value and in good faith are generally protected; the rule primarily catches the initial recipient and anyone further down the chain who did not pay fair value.

A creditor who is forced to return a preferential payment is not completely out of luck. The Bankruptcy Code treats the resulting claim as if it had existed before the filing date, so the creditor can file an unsecured claim against the estate for the amount returned.⁸ That claim will typically pay only a fraction of the original amount, which is exactly the point. The creditor ends up sharing equally rather than taking a full payment at everyone else’s expense.

Extra Risk for Debtors Who Hid Assets

Losing an asset to a clawback is not the worst outcome a debtor can face. If the court finds the debtor transferred property within one year before filing with intent to cheat creditors, the debtor can lose their entire bankruptcy discharge, meaning none of their debts get wiped out.⁹ The same applies to property transferred after the case is filed. Going through the entire bankruptcy process and still owing everything is about as bad an outcome as the system produces.

Intentional concealment of assets can also trigger federal criminal prosecution. Knowingly hiding property from the estate, lying under oath about assets, or filing fraudulent claims carries penalties of up to five years in prison and substantial fines.¹⁰ Criminal bankruptcy fraud cases are uncommon relative to the overall number of filings, but the Department of Justice does pursue them, especially when the amounts are large or the scheme is brazen. That risk is the strongest reason never to try to hide assets from the process.

1
Office of the Law Revision Counsel. 11 USC 548 – Fraudulent Transfers and Obligations
2
Office of the Law Revision Counsel. 11 USC 547 – Preferences
3
Office of the Law Revision Counsel. 11 US Code 546 – Limitations on Avoiding Powers
4
Office of the Law Revision Counsel. 11 US Code 548 – Fraudulent Transfers and Obligations
5
Federal Register. Adjustment of Certain Dollar Amounts Applicable to Bankruptcy Cases
6
Legal Information Institute. Federal Rules of Bankruptcy Procedure Rule 7001 – Types of Adversary Proceedings
7
Office of the Law Revision Counsel. 11 USC 550 – Liability of Transferee of Avoided Transfer
8
Office of the Law Revision Counsel. 11 USC 502 – Allowance of Claims or Interests
9
Office of the Law Revision Counsel. 11 USC 727 – Discharge
10
Office of the Law Revision Counsel. 18 US Code 152 – Concealment of Assets; False Oaths and Claims; Bribery