The Clawback Provision: When Someone Else's Bankruptcy Can Cost You

2 April 2015
 Categories: , Blog


You've just opened the mail and received a nasty shock: your nephew (or other relative) has filed for Chapter 7 bankruptcy and the bankruptcy trustee has filed suit to reclaim the $10,000 loan he repaid you 9 months ago. How can this happen and what do you do now?

It's Called Preferential Debt Payment

Basically, the trustee is alleging that your relative (or even a friend) made preferential payments on his debt to you, which is unfair to any other creditors. The assumption is that your relative was already insolvent during that time and knew that he'd eventually file for bankruptcy. As such, he was trying to pay you back probably out of a greater sense of obligation than he felt toward his other creditors.

You're probably understandably upset, frustrated, and maybe even angry. You didn't do anything wrong, so can the bankruptcy trustee even do this?

It's Called The Clawback Provision

Unfortunately, yes, the bankruptcy trustee does have the right to take back the money under something commonly called the "clawback provision." It doesn't happen often, and usually occurs when the debt that was repaid was significant - although any repayment of more than $600 is enough to trigger the action.

The trustee isn't claiming that you weren't owed the money. Unless your friend or relative is trying to hide assets through you, there's no reason to fear that you're in serious trouble with the law. However, bankruptcy laws are designed to ensure that all of a debtor's creditors are equally compensated with whatever funds are available - and says that it's unfair that one or two receive special treatment.

Contact A Bankruptcy Attorney

It's a mistake to assume that you have to pay back the full amount demanded by the trustee without trying to dispute the clawback provision. Even when it isn't fully possible to avoid paying some of the money, you should see if an attorney can negotiate a lower amount.

In order to establish a preference claim to a friend or relative, the trustee has to show that:

  • the payment was made within the previous year prior to the bankruptcy filing,
  • the debtor was insolvent, and
  • that you received more money than you would have had the debt been treated equally with the person's other debts.

It's possible to mount several different types of defenses against the clawback provision. For example, if your relative had given you some collectible items to hold as collateral against the debt, it was a secured debt and wouldn't be subject to the clawback provision.

There are other ways to attack the clawback provision as well, depending on the laws of your state, so if you find yourself in this situation, contact a bankruptcy attorney (such as Thrush Douglas L Attorney at Law) as quickly as possible in order to protect your rights.