How Long Is the Clawback Period in Bankruptcy?

A clawback period in bankruptcy refers to a specific timeframe before a person or company files for bankruptcy during which certain financial transactions can be reversed. When a bankruptcy case is filed, a trustee is appointed to review the debtor’s recent financial history. This “look-back” window allows the trustee to identify and reclaim assets or funds that were transferred out of the debtor’s possession to ensure they are available for distribution.

The look-back period is a defined statutory timeframe, and any transactions falling within it are subject to scrutiny. The specific length of this period and the types of transactions targeted depend on the nature of the transfer, the recipient, and the applicable laws.

The Purpose of Clawbacks in Bankruptcy

The purpose of clawback provisions is to ensure the fair and equitable distribution of a debtor’s assets among all creditors. When a bankruptcy petition is filed, a “bankruptcy estate” is formed, which consists of all the debtor’s property. This estate is the pool of assets that will be used to pay off outstanding debts, and the trustee’s primary responsibility is to maximize its value for all creditors.

Before filing for bankruptcy, a debtor might make payments or transfer assets that improperly favor certain recipients. By allowing the trustee to reverse these transactions, the law aims to prevent a disorganized and unfair rush by creditors to grab assets just before a bankruptcy filing. The recovered assets are restored to the bankruptcy estate for distribution according to the priority rules set forth in the U.S. Bankruptcy Code.

Identifying Preferential Transfers

A focus for a bankruptcy trustee is identifying preferential transfers. These are not illegal or fraudulent, but are considered unfair to the general pool of creditors. A preferential transfer is a payment or transfer of property to a creditor for a pre-existing debt, made while the debtor was insolvent, that allows that creditor to receive more than they would have in a Chapter 7 liquidation. The law presumes a debtor is insolvent during the 90 days immediately before filing for bankruptcy.

The U.S. Bankruptcy Code, under Section 547, establishes two look-back periods for these transfers. For most creditors, the clawback period is 90 days before the bankruptcy petition was filed. If a debtor pays off a credit card within this window, the trustee may recover that money. A much longer clawback period of one year applies to transfers made to “insiders.” An insider is someone with a close relationship to the debtor, such as a relative or a director of a corporation. This extended timeframe recognizes that insiders may have unique influence and access to information.

Uncovering Fraudulent Conveyances

Separate from preferential transfers are fraudulent conveyances, which are viewed more seriously and have a longer look-back period under federal law. Section 548 of the U.S. Bankruptcy Code gives the trustee the power to claw back fraudulent transfers made within two years before the bankruptcy filing. These transfers are generally divided into two categories.

The first type is “actual fraud.” This occurs when a debtor transfers assets with the specific intent to hinder, delay, or defraud creditors. An example would be selling a valuable piece of real estate to a friend for a fraction of its worth to hide it from the bankruptcy estate.

The second type is “constructive fraud,” where the debtor’s intent is irrelevant. A transfer is considered constructively fraudulent if the debtor received less than “reasonably equivalent value” in exchange for the asset at a time when they were insolvent. For instance, if a person who is unable to pay their debts gives a car worth $20,000 to a child as a gift, the trustee could likely claw back the vehicle or its value.

State Law Influence on Clawback Periods

A trustee’s power to claw back assets is not limited to the timeframes set by the federal Bankruptcy Code. Trustees can also utilize state laws, which can significantly extend the look-back period for certain transactions. This power is granted under Section 544 of the Bankruptcy Code, which allows the trustee to use any applicable state laws to recover property.

Many states have adopted versions of the Uniform Voidable Transactions Act (UVTA). These state-level statutes often provide for much longer clawback periods for fraudulent conveyances than the two-year window available under federal bankruptcy law. It is common for these state laws to allow a look-back period of four years or even longer from the date of the transfer.

This gives the trustee a strategic option. If a fraudulent transfer occurred three years before the bankruptcy filing, it would be outside the reach of the federal two-year clawback period. However, the trustee could invoke the relevant state’s four-year statute to pursue and recover those assets for the benefit of the bankruptcy estate.