What is a bankruptcy trustee? And why are they suing me?

By: Thomas Zeichman June 22, 2022 1:04 pm

A bankruptcy trustee is a professional fiduciary appointed in a bankruptcy case. A bankruptcy trustee is always appointed in Chapter 7 and 13 cases.  Depending on the circumstances, a bankruptcy trustee may be appointed in a Chapter 11 case.

Additionally, many large Chapter 11 bankruptcy cases include litigation trusts in their Chapter 11 plans. This provision appoints a trustee to pursue claims and causes of action.

Among the favored litigation claims of bankruptcy trustee are found in Chapter 5 of the Bankruptcy Code, fraudulent transfer and preference claims.  These types of litigation are often referred to as Avoidance Actions.

What is an Avoidance Action? And do I really have to return money the debtor company paid me?

Avoidance Actions generally take 2 forms: preference claims and fraudulent transfers.  Each type of cause of action seeks either a money judgment for the amount transferred or return of the property transferred from the debtor.

Preference Claims

Among the most confusing litigation for a defendant business are preference claims. Essentially, you or your business are sued for being paid prior to bankruptcy by the now bankrupt company.  The bankruptcy trustee is able to recover these funds paid to: (i) non-insiders during the 90 day period pre-bankruptcy; or (ii) to insiders during the 1 year period before the bankruptcy was filed.  The policy underlying these preference claims are that similarly situated creditors should be treated as equal as possible.

Unless a defense applies, a bankruptcy trustee is able to recover preference claims if they establish all of the below elements:

• The debtor transferred its property, including money, to or for the benefit of a creditor.
• The transfer was made for a debt that existed before the transfer was made that the debtor owed to the creditor (such as outstanding invoices).
• The transfer was made when the debtor was insolvent.
• The transfer to non-insider was made within 90 days of the debtor’s bankruptcy filing, or within one year of the debtor’s bankruptcy filing if the transfer was to an insider.
• The transfer allowed the creditor to receive more than the creditor would have received in a chapter 7 liquidation of the debtor.

Frequently, trade creditors are targets of preference litigation as they were doing business in the debtor company in the months leading up to the bankruptcy filing.

Fraudulent Transfers: Actual and Constructive Fraudulent Transfer

            When a person hears the word “fraud” images of schemes and theft jump to mind. But under Florida law and the Bankruptcy Code, a recipient of funds or property from the bankrupt debtor may become subject to fraudulent transfer liability without any bad intent from the recipient. Fla. Stat. 726.105 addresses fraudulent transfers in Florida. There are two types: actual and constructive fraudulent transfers.

Actual Fraudulent Transfer

To establish an actual fraudulent transfer claim a bankruptcy trustee must prove: (i) the existence of a creditor of the debtor/seller; (ii) a transfer of property available to pay debts; and (iii) the debtor/seller intended a fraud. Rarely does a debtor admit to committing fraud. Therefore, the intent element is determined by evaluating the “badges of fraud” which include:

(a) The transfer or obligation was to an insider.

(b) The debtor retained possession or control of the property transferred after the transfer.

(c) The transfer or obligation was disclosed or concealed.

(d) Before the transfer was made or obligation was incurred, the debtor had been sued or threatened with suit.

(e) The transfer was of substantially all the debtor’s assets.

(f) The debtor absconded.

(g) The debtor removed or concealed assets.

(h) The value of the consideration received by the debtor was reasonably equivalent to the value of the asset transferred or the amount of the obligation incurred.

(i) The debtor was insolvent or became insolvent shortly after the transfer was made or the obligation was incurred.

(j) The transfer occurred shortly before or shortly after a substantial debt was incurred.

(k) The debtor transferred the essential assets of the business to a lienor who transferred the assets to an insider of the debtor.

Constructive Fraudulent Transfer

The second type of fraudulent transfer, a constructive fraudulent transfer, is less concerned with the intent of the transferor/debtor and instead focuses on the financials of the deal and the debtor pre-bankruptcy. A creditor of the seller suing a purchaser for constructive fraudulent transfers would have to establish that:

(1) the seller did not receive “reasonably equivalent value” in exchange for the transfer; and (2) the seller:

(a) was engaged or was about to engage in a business or a transaction for which the remaining assets of the debtor were unreasonably small in relation to the business or transaction;

(b) intended to incur, or believed or reasonably should have believed that he or she would incur, debts beyond his or her ability to pay as they became due (often referred to as “Cash Flow Insolvency”); or

(c) was insolvent at that time or the debtor became insolvent as a result of the transfer or obligation (known as “Balance Sheet Insolvency”).

Fla. Stat. 726.105.

This scenario may arise pre-bankruptcy debtor sells assets for below market prices while insolvent or close to insolvency.

How much time does the bankruptcy trustee have to sue me for an Avoidance Action?

Generally, bankruptcy trustee has the later of: (i)  2 years from the date the bankruptcy was filed; or (ii) 1 year from the date of appointment to commence an Avoidance Action.  It is possible the bankruptcy trustee may seek Court approval to extend this deadline.

Following the emergence of COVID and the corresponding lockdowns, large commercial bankruptcy filings spiked in the May through August 2020 period.

Source: https://www.natlawreview.com/article/bankruptcy-filings-excerpt-trends-large-corporate-bankruptcy-and-financial-distress

As we enter 2 year anniversary of the commercial bankruptcy spike, bankruptcy trustees are deciding whether to file Avoidance Actions against various parties.

How will a bankruptcy trustee contact you about an Avoidance Action?

Frequently, a bankruptcy trustee will attempt to make contact before filing a lawsuit.  And contact is often made by US Mail or E-mail to your last known address.  If you have changed your email or physical address since you last dealt with the bankrupt company, then you may not receive notice unless you update the bankruptcy court.

What should you do if you receive a letter from a bankruptcy trustee?  Consider consulting with a bankruptcy attorney to determine how and if you should respond to the demand letter. Depending on the bankruptcy trustee and facts, an informative and legally sound response could be the end of the matter. Additionally, it is important to locate any records you have related to your business dealings with the bankrupt company.  These records may include payment history documents and invoices, among other information. These documents will help guide your response and may even support a defense to the claim.

Next Steps

As bankruptcy trustees begin or continue to send out Avoidance Action demand letters or commence lawsuits, it is important to monitor bankruptcy cases and communications from bankruptcy trustees.  Avoidance Actions required attention and prompt action to avoid, among other consequences, a default judgment due to a lack of response.

Questions? BMU+L Law Team Members:

Thomas Zeichman (Bankruptcy, Restructuring, and Insolvency Litigation)

This blog is made available by Beighley, Myrick, Udell, Lynne + Zeichman, P.A. “BMU Law” for informational purposes only. It is not meant to convey the Firm’s legal position on behalf of any client, nor is it intended to convey specific legal advice. Any opinions expressed in this article do not necessarily reflect the views of Beighley, Myrick, Udell, Lynne + Zeichman, P.A. “BMU Law”, its partners, or its clients. Accordingly, do not act upon this information without seeking counsel from a licensed attorney. This blog is not intended to create, and receipt of it does not constitute, an attorney-client relationship.

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