WHICH TRANSACTIONS CAN BE AVOIDED BY THE BANKRUPTCY TRUSTEE UNDER CHAPTER 7 PROCEEDINGS ?
The Bankruptcy Code gives a Chapter 7 trustee significant powers to avoid certain transactions entered into by the debtor before the bankruptcy case commenced. These powers are intended to protect the bankruptcy estate and preserve the principle of equal and fair distribution among creditors. A debtor may, before filing bankruptcy, have transferred property, made preferential payments to particular creditors, or entered into transactions that improperly reduced the assets available to the general body of creditors. The trustee’s avoidance powers enable the trustee, subject to the applicable statutory requirements and defenses, to recover property or value for the bankruptcy estate.
The trustee’s avoidance powers arise primarily under Chapter 5 of the Bankruptcy Code, particularly 11 U.S.C. §§ 544, 545, 547, 548, and 549, together with related recovery provisions such as § 550. These provisions address different types of transactions and circumstances. For example, the trustee’s strong-arm powers under § 544 may permit the trustee to avoid certain interests that would be unenforceable against a hypothetical lien creditor or bona fide purchaser; § 547 addresses preferential transfers; § 548 addresses certain fraudulent or constructively fraudulent transfers; and § 549 concerns certain unauthorized transfers of estate property made after the commencement of the case. When a transfer is successfully avoided, § 550 generally provides the mechanism for recovering the property or its value for the benefit of the bankruptcy estate.
TRUSTEE’S AVOIDANCE POWERS UNDER SECTION 544
11 U.S.C. § 544 gives the Chapter 7 trustee broad “strong-arm” powers to avoid certain transfers, liens, and other interests affecting the debtor’s property. Under § 544(a), the trustee is given the rights and powers of specified hypothetical parties as of the commencement of the case, including a judicial lien creditor, an execution creditor, and, in the case of real property, a bona fide purchaser. These powers enable the trustee to challenge certain interests that would not be enforceable against such hypothetical parties under applicable non-bankruptcy law. The purpose is to prevent unperfected or otherwise legally vulnerable interests from defeating the rights of the bankruptcy estate.
For example, suppose a debtor owns a house worth $300,000. Before filing bankruptcy, the debtor grants a lender a mortgage on the house, but the lender fails to properly record or perfect the mortgage under applicable state law. The debtor later files Chapter 7. Under 11 U.S.C. § 544(a)(3), the trustee is treated as a hypothetical bona fide purchaser of the real property as of the bankruptcy filing date. If a bona fide purchaser under state law could acquire the property without being bound by the unrecorded mortgage, the trustee may use the strong-arm power to avoid the lender’s mortgage. As a result, the lender may lose its secured status against the bankruptcy estate, and the property may be treated as unencumbered for purposes of the trustee’s administration of the estate. The lender would generally have only an unsecured claim, subject to the applicable circumstances.
Section 544(b)(1) provides an additional and significant avoidance power. It allows the trustee to avoid a transfer of an interest of the debtor in property, or an obligation incurred by the debtor, that an actual unsecured creditor could have avoided under applicable non-bankruptcy law, provided that such creditor holds an allowable unsecured claim and the statutory requirements are satisfied. In effect, the trustee may step into the position of an actual creditor and exercise that creditor’s avoidance rights for the benefit of the bankruptcy estate. This can include, for example, rights available under applicable state fraudulent-transfer or similar laws. Section 544(b) is therefore different from § 544(a). while § 544(a) creates hypothetical creditor and purchaser rights, § 544(b) permits the trustee to utilize an avoidance right that belongs to an actual unsecured creditor under applicable non-bankruptcy law.
For example, suppose a debtor owes $100,000 to Creditor A, an unsecured creditor. Shortly before filing Chapter 7, the debtor transfers a valuable property worth $150,000 to a relative for only $20,000, intending to place the property beyond the reach of creditors. Under the applicable state fraudulent-transfer law, Creditor A could have brought an action to avoid that transfer because the debtor transferred the property for substantially less than its value and the statutory requirements for a fraudulent transfer are satisfied. After the debtor files bankruptcy, Creditor A does not need to bring the action itself. Under § 544(b)(1), the Chapter 7 trustee can step into Creditor A’s position and exercise the avoidance right that Creditor A could have exercised under state law. If the trustee successfully avoids the transfer, the property or its value can be recovered for the benefit of the bankruptcy estate, subject to the applicable provisions of the Bankruptcy Code.
AVOIDANCE OF STATUTORY LIENS
11 U.S.C. § 545 deals with statutory liens and gives the bankruptcy trustee the power to avoid certain statutory liens against property of the debtor. The provision is intended to prevent certain liens that arise automatically under non-bankruptcy law from obtaining an advantage over the bankruptcy estate merely because of the debtor’s bankruptcy, insolvency, or financial difficulties, or because the lien was not properly perfected before the commencement of the case.
A statutory lien is a lien that arises by operation of law rather than as a result of an agreement between the debtor and the creditor. In other words, the lien does not depend upon the debtor voluntarily granting a security interest or mortgage to the creditor. Examples may include certain tax liens, landlord’s liens, mechanics’ liens, and liens arising under statutes that grant creditors an interest in specified property upon the occurrence of particular conditions. Section 101(53) of the Bankruptcy Code defines a statutory lien and distinguishes it from a judicial lien and a security interest created by agreement.
Section 545 identifies particular circumstances in which the trustee may avoid a statutory lien. One important category concerns a lien that first becomes effective against the debtor because of the commencement of the bankruptcy case, the debtor’s insolvency or financial condition, or the appointment of a custodian of the debtor’s property. Congress did not intend a creditor to obtain an enhanced lien position merely because the debtor entered bankruptcy or became insolvent. Thus, where the effectiveness of the statutory lien depends upon one of these events, the trustee may have authority to avoid it.
The trustee may also avoid certain statutory liens that, at the commencement of the bankruptcy case, were not perfected or enforceable against a hypothetical bona fide purchaser of the property. This provision is particularly important because it prevents an incompletely perfected statutory lien from defeating the interests of the bankruptcy estate. The trustee is given the ability to challenge the lien based upon the rights of a hypothetical bona fide purchaser, similar in concept to the trustee’s strong-arm powers under § 544(a). The precise requirements for avoidance, however, depend upon the particular subsection of § 545 and the nature of the lien involved.
Section 545 also contains specific provisions concerning liens for rent and liens of distress for rent. These provisions reflect Congress’s determination that certain landlord’s liens arising by operation of law should not be permitted to interfere with the administration of the bankruptcy estate in circumstances covered by the statute. Accordingly, a trustee may avoid a lien for rent or a lien of distress for rent when the statutory requirements of § 545 are satisfied.
For example, assume that a debtor operates a retail business in leased premises and owes the landlord several months of rent. Under applicable state law, the landlord may have a statutory lien arising automatically against certain property of the debtor located on the leased premises. If the lien falls within the circumstances described in § 545 and is avoidable under that section, the Chapter 7 trustee may seek to invalidate the lien to the extent permitted by the Bankruptcy Code. The property can then be administered as part of the bankruptcy estate rather than being removed from the estate’s control by an otherwise avoidable statutory lien.
It is important to distinguish statutory liens from consensual security interests and judicial liens. A consensual security interest generally arises because the debtor voluntarily granted an interest in property to secure a debt, while a judicial lien generally results from a judgment, levy, or other judicial process. A statutory lien, by contrast, arises automatically by operation of a statute. Section 545 specifically addresses the latter category and provides the trustee with targeted avoidance powers.
The practical purpose of § 545 is therefore to protect the bankruptcy estate from certain statutory liens that are legally vulnerable at the commencement of the case. Avoidance of such a lien does not necessarily mean that the underlying debt disappears. Rather, the creditor may lose its lien or secured position and may instead hold a claim against the estate according to the classification and priority applicable under the Bankruptcy Code.
LIMITATION ON AVOIDANCE POWERS OF TRUSTEE
11 U.S.C. § 546 deals with the limitations on the trustee’s avoiding powers. In other words, after §§ 544 and 545 give the trustee certain powers to avoid transfers and liens, § 546 places limits on when and how those powers can be exercised.
The most important provision is § 546(a). It establishes a time limit for bringing an action under §§ 544, 545, 547, 548, or 553. Generally, the action must be commenced by the earlier of (1) the later of two years after the entry of the order for relief or one year after the appointment or election of the first trustee in specified circumstances, or (2) the time the bankruptcy case is closed or dismissed.
Section 546(b) protects certain creditors whose rights under generally applicable non-bankruptcy law allow them to perfect or maintain perfection of an interest in property even after another creditor has acquired rights in that property. This is particularly relevant where state law permits perfection to relate back to an earlier date.
Section 546(c) deals with the right of a seller of goods to reclaim goods sold to the debtor in the ordinary course of business when the debtor received those goods while insolvent, subject to specified notice and timing requirements.
Subsections § 546(d)–(j) contain additional limitations and protections, particularly concerning grain and fish sellers, financial-market transactions, repurchase agreements, swap agreements, the return of goods in certain Chapter 11 cases, warehousemen’s liens, and master netting agreements.
AVOIDANCE OF PREFERRENTIAL TRANSFERS
11 U.S.C. § 547 governs preferential transfers and gives the Chapter 7 trustee the power to avoid certain transfers made by the debtor before the commencement of the bankruptcy case. The fundamental purpose of the provision is to prevent a debtor from favoring one creditor over other creditors shortly before bankruptcy and thereby disturbing the principle of equal distribution among similarly situated creditors. A preference generally occurs when a debtor pays or transfers property to a creditor on account of an existing debt shortly before bankruptcy and the creditor receives more than it would have received if the transfer had not been made and the debtor’s estate had instead been distributed under Chapter 7.
Definition of Transfer and Trustee’s Avoidance Power
Section 547(a) provides definitions that are important for applying the preference provisions. The term “transfer” is broadly defined through the Bankruptcy Code and includes, among other things, the creation of a lien, payment of money, or disposition of an interest in property.
Under § 547(b), the trustee may avoid a transfer of an interest of the debtor in property when all of the statutory requirements are satisfied. Generally, the trustee must establish that the transfer was to or for the benefit of a creditor, was made for or on account of an antecedent debt, was made while the debtor was insolvent, occurred within the applicable statutory period before the filing of the bankruptcy petition, and enabled the creditor to receive more than it would have received in a Chapter 7 liquidation if the transfer had not been made. The provision therefore focuses on whether the transaction improperly improved the position of one creditor at the expense of the creditor body as a whole.
Preference Period and Presumption of Insolvency
For most creditors, the relevant preference period under § 547(b)(4) is the 90 days immediately preceding the commencement of the bankruptcy case. A longer period applies to certain transfers made for the benefit of an insider. Under the statute, the trustee may generally examine qualifying transfers made during the one-year period preceding the petition when the transfer was made to or for the benefit of an insider.
The Code also provides an important evidentiary rule in § 547(f). For purposes of the preference provisions, the debtor is presumed to have been insolvent during the 90 days immediately preceding the date of the filing of the petition. This presumption assists the trustee in establishing the insolvency element of a preference claim, although the creditor may seek to rebut the presumption with appropriate evidence.
Transfers to Insiders
Section 547(b)(4)(B) extends the preference period to one year before the commencement of the case when the transfer was made to or for the benefit of an insider. This longer period reflects the concern that debtors may favor relatives, closely connected business persons, or other insiders before filing bankruptcy. The statute therefore permits the trustee to scrutinize certain payments or transfers to insiders that occurred earlier than the ordinary 90-day preference period.
Defenses to Preference Avoidance
Although § 547(b) gives the trustee substantial avoidance powers, § 547(c) provides several important defenses and exceptions. These provisions recognize that some payments made shortly before bankruptcy are legitimate commercial transactions and should not automatically be recovered by the trustee.
Among the principal defenses are transfers that were intended as and were in fact a contemporaneous exchange for new value; transfers made in the ordinary course of business or financial affairs of the debtor and creditor; transfers that created a purchase-money security interest satisfying the statutory requirements; and transfers to the extent that the creditor subsequently provided new value to the debtor. The statute also contains specialized protections for certain transactions involving consumer debts, educational institutions, domestic support obligations, wages, taxes, securities contracts, financial contracts, and other transactions identified in § 547(c). The availability of a defense depends upon the particular facts and the specific statutory requirements.
Certain Transfers Protected From Avoidance
Section 547(d) contains a special rule concerning certain charitable contributions. Under specified circumstances, a trustee may not avoid a transfer of a charitable contribution to a qualified religious or charitable entity or organization under § 170(c) of the Internal Revenue Code. The protection is subject to the limitations and requirements set forth in the statute, including rules concerning the amount of the contribution in relation to the debtor’s income.
Effect of Subsequent New Value
The preference provisions take account of situations in which a creditor gives new value after receiving a transfer from the debtor. Under § 547(c)(4), a creditor may have a defense to the extent that, after receiving the challenged transfer, the creditor subsequently gave new value to or for the benefit of the debtor that was not secured by an otherwise unavoidable security interest and was not repaid by an otherwise unavoidable transfer. This rule recognizes that a creditor who continues to provide value to a financially troubled debtor may have a reduced preference exposure.
Section 547(e) contains detailed rules concerning when a transfer is deemed to have been made, particularly where the transfer involves a security interest. These timing rules can be critical in determining whether a transfer occurred within the applicable preference period. For example, the date on which a security interest is perfected may determine whether the transfer is treated as having occurred when the security interest was created or at a later date.
Special Rules Concerning Security Interests and Floating Liens
Section 547 also contains special rules concerning the perfection of security interests. A creditor who obtains a lien shortly before bankruptcy may, depending upon the circumstances, have received a preferential transfer even though the transaction was structured as a secured transaction rather than an ordinary payment. The timing of attachment and perfection, together with the statutory rules in § 547(e), therefore becomes important in determining whether the trustee can avoid the transfer.
The Code also contains specific protection for certain purchase-money security interests under § 547(c)(3), provided the creditor satisfies the statutory timing and perfection requirements. These provisions seek to distinguish legitimate financing transactions from transactions that improperly improve an existing creditor’s position immediately before bankruptcy.
Protection for Certain Floating Liens
Section 547(c)(5) provides a special limitation on avoidance involving certain floating liens on inventory, accounts, and other property. The provision generally prevents a trustee from avoiding certain transfers to the extent that the creditor’s position did not improve during the applicable preference period. This rule is particularly relevant in commercial cases involving revolving credit arrangements and security interests covering changing pools of assets.
Transfers Involving Domestic Support Obligations
The Code also provides special protection for certain transfers made in connection with domestic support obligations. Under § 547(c)(7), the trustee may not avoid a transfer to or for the benefit of a spouse, former spouse, or child of the debtor when the debt is a domestic support obligation, subject to the statutory conditions. This reflects the Bankruptcy Code’s policy of protecting certain family-support payments from avoidance.
Transfers Relating to Educational Institutions
Sections 547(c)(8) and (9) establish additional limitations concerning certain transfers made in connection with educational institutions and small-value consumer transfers. These provisions recognize that the cost and administrative burden of pursuing relatively small preference claims may outweigh the potential benefit to the estate. The statutory thresholds and requirements must be examined carefully when determining whether a trustee may pursue such a transfer.
Consumer Debt and Certain Small Transfers
Section 547 contains additional provisions designed to address small consumer transactions and prevent the bankruptcy estate from incurring disproportionate litigation costs in pursuing relatively insignificant transfers. These provisions establish monetary thresholds and other conditions under which certain transfers cannot be avoided. Their practical importance is greatest in individual Chapter 7 cases, where numerous small payments may have been made before bankruptcy.
Burden of Proof
Section 547(g) allocates the burden of proof in preference litigation. The trustee has the burden of proving the avoidability of a transfer under § 547(b), while the party against whom recovery is sought has the burden of proving the non-avoidability of the transfer under § 547(c). This distinction is important because the trustee must first establish the statutory elements of a preference, after which the creditor may rely upon an applicable defense or exception.
AVOIDANCE OF FRAUDULENT TRANSFERS
11 U.S.C. § 548 is the principal federal provision dealing with the avoidance of fraudulent transfers and certain obligations incurred by a debtor. It permits the bankruptcy trustee, subject to the statutory requirements, to avoid certain transactions entered into before the commencement of the bankruptcy case that either were made with an intent to hinder, delay, or defraud creditors or involved an inadequate exchange of value while the debtor was financially distressed. The provision is therefore an important tool for preventing a debtor from improperly removing assets from the reach of creditors before filing for bankruptcy.
General Avoidance Power
Section 548(a)(1) establishes the principal grounds on which a trustee may avoid a transfer of an interest of the debtor in property or an obligation incurred by the debtor. It contains two principal categories of avoidable transactions: those involving actual fraudulent intent under § 548(a)(1)(A) and those involving constructive fraud under § 548(a)(1)(B).
Actual Fraud
Under § 548(a)(1)(A), the trustee may avoid a transfer or obligation if it was made or incurred with the actual intent to hinder, delay, or defraud creditors. The trustee does not necessarily have to prove that the debtor expressly admitted such an intention. Actual intent may be established from the surrounding circumstances, often referred to as the badges of fraud, such as a transfer to an insider or close relative, concealment of the transaction, retention of possession or control of the property after the transfer, the timing of the transfer shortly before bankruptcy, or the absence of reasonably equivalent consideration. For example, if a debtor facing substantial creditor claims transfers a valuable asset to a relative without receiving fair value and continues to exercise control over the asset, the trustee may seek to avoid the transfer if the circumstances establish an intent to hinder, delay, or defraud creditors.
Constructive Fraud
Section 548(a)(1)(B) deals with what is commonly called constructive fraud. Unlike § 548(a)(1)(A), this provision does not require proof of the debtor’s actual intent to defraud creditors. A transfer or obligation may be avoided if the debtor received less than reasonably equivalent value in exchange and one of the financial conditions specified in the statute existed. These conditions include circumstances in which the debtor was insolvent or became insolvent as a result of the transaction, was engaged in or was about to engage in a business or transaction for which the debtor’s remaining property constituted unreasonably small capital, intended to incur or reasonably should have believed that the debtor would incur debts beyond the debtor’s ability to pay as they matured, or, in certain circumstances, made the transfer for the benefit of an insider. For example, if a debtor whose financial condition is deteriorating transfers property worth $100,000 for only $20,000 and the transaction leaves the debtor insolvent, the trustee may be able to avoid the transfer even if there is insufficient evidence to establish an actual intention to defraud creditors.
Charitable Contributions
Section 548(a)(2) contains special provisions concerning certain charitable contributions made by an individual debtor. The Bankruptcy Code recognizes that individuals may make legitimate charitable contributions and therefore provides protection for qualifying contributions within the statutory limits. At the same time, the provision permits avoidance of certain contributions that exceed the protection provided by the statute. The purpose is to balance the debtor’s legitimate interest in making charitable contributions with the interests of creditors in preventing excessive transfers of assets that should otherwise be available for distribution through the bankruptcy estate.
Certain Transfers by Entities
Section 548(b) addresses certain transfers of property by specified entities in circumstances covered by the provision. Its application is narrower than the general fraudulent-transfer provisions contained in § 548(a), and it should therefore be read together with the particular statutory requirements applicable to the type of debtor and transaction involved.
Protection of Good-Faith Transferees
Section 548(c) provides protection to a transferee or obligee that received property or incurred an obligation in good faith. Where a trustee successfully avoids a transfer, a transferee that acted in good faith may nevertheless be entitled to retain or assert an interest in the property to the extent provided by the statute, generally based upon the value given in exchange for the transfer. This provision recognizes that a person who receives property from a debtor is not necessarily a participant in the debtor’s fraudulent conduct and may therefore receive statutory protection if the requirements of § 548(c) are satisfied.
Timing and Perfection of Transfers
Section 548(d) contains rules concerning when a transfer is considered to have been made for purposes of § 548 and addresses related issues concerning the perfection and enforceability of transfers. These rules are important because the trustee’s avoidance power under § 548 is subject to a statutory lookback period. Determining the date on which a transfer is legally considered to have occurred may therefore determine whether the trustee can challenge the transaction under the section.
Transfers to Self-Settled Trusts
Section 548(e) deals with certain transfers made by an individual debtor to a self-settled trust or similar device in which the debtor is a beneficiary. Where the statutory requirements are satisfied, the trustee may avoid certain such transfers made with the intent to hinder, delay, or defraud creditors. This provision is particularly significant because it establishes a special ten-year lookback period for qualifying transfers, substantially longer than the ordinary federal lookback period applicable under § 548(a).
Educational Savings Accounts
Section 548(f) contains special rules concerning certain transfers relating to educational savings accounts and similar arrangements. Subject to the conditions and limitations prescribed by the statute, certain qualifying contributions may receive protection from avoidance. These provisions reflect Congress’s intention to protect specified educational savings arrangements while preventing improper transfers designed to place assets beyond the reach of creditors.
AVOIDANCE OF POST PETITION TRANSFERS
Section 549(a) authorizes the trustee to avoid a transfer of property of the bankruptcy estate when the transfer occurs after commencement of the case and is either not authorized under the Bankruptcy Code or by the bankruptcy court, subject to the exceptions contained in subsections (b) and (c). The provision also covers certain transfers authorized only under § 303(f) or § 542(c). The essential purpose of § 549(a) is to preserve the estate after the commencement of bankruptcy and prevent unauthorized disposition of estate property.
For example, if a debtor sells or transfers property that has become part of the bankruptcy estate after the petition is filed, without authority under the Bankruptcy Code or an order of the bankruptcy court, the trustee may seek to avoid that transfer under § 549(a). The provision therefore operates as an important safeguard against postpetition depletion of estate assets.
Protection for Certain Transfers in Involuntary Cases
Section 549(b) establishes a special protection in an involuntary bankruptcy case. It applies to a transfer made after commencement of the case but before the order for relief. The trustee cannot avoid such a transfer to the extent that the transferee provided value, including services, after commencement of the case in exchange for the transfer.
The protection does not extend to value given merely to satisfy or secure a debt that arose before the commencement of the case. Importantly, the transferee’s knowledge or notice of the bankruptcy case does not affect this protection. The provision is intended to protect persons who continue to provide goods, services, or other value during the period between commencement of an involuntary case and entry of the order for relief.
Protection for Good-Faith Purchasers of Real Property
Section 549(c) protects certain good-faith purchasers of real property from the trustee’s avoidance power. A transfer of an interest in real property generally cannot be avoided when the purchaser acted in good faith, had no knowledge of the commencement of the bankruptcy case, and gave present fair equivalent value, provided the statutory recording and perfection requirements are satisfied.
The provision also addresses a purchaser who acted in good faith and without knowledge but paid less than present fair equivalent value. In that circumstance, the purchaser may obtain a lien on the property to the extent of the present value given, unless the required notice of the bankruptcy petition was filed before the transfer was perfected. Section 549(c) therefore balances the trustee’s interest in protecting estate property with the need to protect innocent purchasers who acquire real property without knowledge of the bankruptcy case.
Time Limit for Avoidance Actions
Section 549(d) establishes the time limit for bringing an action or proceeding under § 549. The trustee must commence the action by the earlier of – two years after the date of the transfer sought to be avoided, or the time the bankruptcy case is closed or dismissed.
Thus, the trustee’s power under § 549 is subject to a specific statutory limitation period. Once the earlier of these events occurs, an action under § 549 generally may no longer be commenced.
LIABILITY OF TRANSFEREE OF AVOIDED TRANSFER
Section 550 is the recovery provision that works together with the avoidance provisions of Chapter 5. While §§ 544, 545, 547, 548 and 549 determine whether a transfer can be avoided, §550 determines from whom the trustee can recover the property or its value after the transfer has been avoided.
Section 550 of the Bankruptcy Code deals with the recovery of property or its value after a transfer has been avoided under one of the Bankruptcy Code’s avoidance provisions. Sections 544, 545, 547, 548, 549, 553(b), and 724(a) provide the substantive grounds on which certain transfers may be avoided, while §550 provides the mechanism for recovering the transferred property or its value for the benefit of the bankruptcy estate. Thus, avoidance and recovery are related but distinct concepts. Avoidance establishes that the transfer is legally subject to being set aside, while §550 identifies the persons from whom the trustee may recover.
Recovery from the Initial or Subsequent Transferee
Section 550(a) provides that, to the extent a transfer has been avoided under §§544, 545, 547, 548, 549, 553(b), or 724(a), the trustee may recover, for the benefit of the estate, the property transferred or, if the court so orders, the value of that property. Recovery may be sought from two principal categories of persons.
First, under §550(a)(1), the trustee may recover from the initial transferee of the property or from the entity for whose benefit the transfer was made. Second, under §550(a)(2), the trustee may recover from any immediate or mediate transferee of the initial transferee. The reference to immediate or mediate transferees means that liability may extend through successive transfers of the property, subject to the protections contained in §550(b).
A debtor transfers $20,000 to Creditor A in payment of an antecedent debt, and the trustee successfully avoids the payment as a preferential transfer under §547. Under §550(a), the trustee may seek recovery of the $20,000 from Creditor A as the initial transferee. If the property transferred was an identifiable asset that Creditor A subsequently transferred to another person, the trustee may, subject to the statutory protections, potentially pursue the subsequent transferee as well.
Protection of Good-Faith Subsequent Transferees
Section 550(b) protects certain immediate or mediate transferees from liability. The trustee cannot recover under §550(a)(2) from a transferee who took the property for value, including satisfaction or securing of a present or antecedent debt, in good faith and without knowledge of the voidability of the transfer. The protection also extends to an immediate or mediate good-faith transferee of such a protected transferee.
This provision is important because property may pass through several hands after the original transfer. The Bankruptcy Code does not necessarily impose liability on an innocent subsequent purchaser who gave value, acted in good faith, and had no knowledge that the original transfer could be avoided. The protection under §550(b), however, is directed to recovery from subsequent transferees under §550(a)(2), it does not eliminate the trustee’s recovery rights against the initial transferee under §550(a)(1).
A debtor makes a transfer to Creditor A that is later avoided. Creditor A sells the transferred property to Buyer B for fair value. If Buyer B acted in good faith and had no knowledge that the original transfer was voidable, §550(b) may protect Buyer B from recovery by the trustee under §550(a)(2).
Protection for Non-Insider Transferee in Certain Insider Preferences
Section 550(c) establishes a special limitation where a transfer made between 90 days and one year before the bankruptcy petition is avoided as a preference under §547(b), and the transfer was made for the benefit of a creditor who was an insider at the time of the transfer.
In such circumstances, the trustee may not recover under §550(a) from a transferee who is not an insider. This provision prevents the extended one-year preference period applicable to insider transactions from imposing recovery liability on a non-insider transferee in the circumstances specified by the statute.
For example a debtor makes a preferential transfer for the benefit of an insider 10 months before filing bankruptcy. If the transfer is subsequently avoided under §547(b), §550(c) prevents the trustee from recovering under §550(a) from a transferee who is not an insider.
Only One Satisfaction
Section 550(d) provides that the trustee is entitled to only a single satisfaction under §550(a). The trustee therefore cannot obtain multiple recoveries for the same avoided transfer simply because more than one transferee may potentially be liable.
The purpose is to ensure that the bankruptcy estate receives the amount necessary to restore the estate to the position contemplated by the avoidance provisions, rather than receiving a windfall through multiple recoveries.
For example, if the trustee can recover $50,000 from either the initial transferee or a subsequent transferee, the trustee cannot obtain $50,000 from each and thereby recover $100,000 on account of the same avoided transfer.
Lien for Improvements Made by a Good-Faith Transferee
Section 550(e) provides protection to a good-faith transferee from whom the trustee is entitled to recover property. Such a transferee receives a lien on the recovered property to secure the lesser of two amounts: the cost of improvements made after the transfer, less any profit realized or accruing to the transferee from the property, or the increase in the property’s value resulting from those improvements.
The statute broadly defines “improvement” to include physical additions or changes, repairs, payment of taxes, payment of certain debts secured by liens that are superior or equal to the trustee’s rights, and preservation of the property.
For example, transferee receives a piece of property in a transaction that is later avoided. In good faith, the transferee spends $20,000 repairing and preserving the property. If those improvements increase the property’s value by only $15,000, the statutory lien is limited to the lesser amount, subject to the statutory calculation. Conversely, if the improvements increase the value by $25,000 but the qualifying cost is $20,000, the lien is limited to $20,000, before accounting for any applicable profit adjustment.
Time Limit for Recovery Actions
Section 550(f) establishes a limitation period for an action or proceeding seeking recovery under §550. The action may not be commenced after the earlier of – one year after the avoidance of the transfer on which the recovery is based; or the time the bankruptcy case is closed or dismissed.
Thus, even after a transfer has been successfully avoided, the trustee must pursue the recovery within the statutory period prescribed by §550(f).
For example if a transfer is avoided on January 1, the trustee ordinarily has until the earlier of January 1 of the following year or the date on which the bankruptcy case is closed or dismissed to commence the §550 recovery proceeding.
