When a company enters bankruptcy, one of the most important tools available to the trustee or debtor in possession is the ability to unwind certain financial transactions made before and, in some cases, after the filing. These “avoidance actions” are designed to recover value for the bankruptcy estate and ensure that creditors are treated fairly throughout the process.

 

At Dunn Law, P.A., we regularly counsel businesses, fiduciaries, creditors, and professionals who encounter avoidance claims in bankruptcy or state court insolvency proceedings. Understanding how these actions work and the risks they create is essential for any business owner, accountant, advisor, or lender involved with a financially distressed company.

 

Avoidance actions are not intended as punishment. Instead, the Bankruptcy Code gives trustees and debtors in possession these powers to correct transfers that may have favored one creditor over others or depleted the estate during financial distress. By bringing these assets back into the estate, the law promotes fairness and maximizes recoveries for all creditors.

 

Below is an overview of the primary types of avoidance actions, their statutory foundations, and what businesses and advisors should expect when one is asserted.

What Are Avoidance Actions?

 

Under the Bankruptcy Code, avoidance actions allow a trustee or debtor in possession to “avoid,” or unwind, certain transfers made before or after the bankruptcy case is filed. These transfers often involve payments to creditors, asset transfers to insiders, or unauthorized post-petition activity.

 

The four primary categories are:

• Preferences (11 U.S.C. Section 547)
• Actual fraudulent transfers (11 U.S.C. Section 548(a)(1)(A))
• Constructive fraudulent transfers (11 U.S.C. Section 548(a)(1)(B))
• Post-petition transfers (11 U.S.C. Section 549)

Each category serves a different purpose, and the specific facts surrounding a transfer typically determine which one applies.

Preferences (11 U.S.C. Section 547)

 

A preference generally involves a payment or transfer made shortly before the bankruptcy filing that allows one creditor to receive more than it would have received through the ordinary bankruptcy distribution. Preference law is meant to avoid unequal treatment and discourage aggressive collection efforts during a debtor’s financial decline.

 

To establish a preference under Section 547, a trustee must show that a transfer:

• Involved the debtor’s property
• Was made to or for the benefit of a creditor
• Satisfied an antecedent (existing) debt
• Occurred while the debtor was insolvent
• Took place within 90 days before filing, or within one year if the creditor is an insider
• Allowed the creditor to receive more than it would have in a Chapter 7 liquidation

Not every transfer within this timeframe is avoidable. Common defenses include:

• Ordinary course of business - The payment was consistent with how the parties historically operated or how similar businesses operate.
• New value defense - The creditor provided goods, services, or other value after receiving the payment.
• Contemporaneous exchange - The parties intended the exchange to be a near-simultaneous swap of value, not payment of old debt.

These defenses often determine the outcome, making early legal analysis critical.

Actual Fraudulent Transfers (11 U.S.C. Section 548(a)(1)(A))

 

Actual fraudulent transfers involve transactions made with “actual intent to hinder, delay, or defraud” creditors. These cases are fact-driven and frequently arise in situations involving insider relationships, hidden transfers, or asset movements occurring during significant financial stress.

 

To prevail under Section 548(a)(1)(A), a trustee must show:

• The debtor made a transfer or incurred an obligation
• With actual intent to hinder, delay, or defraud creditors

Because debtors rarely admit intent, courts look to “badges of fraud,” such as secretive transactions, transfers to insiders, or transactions for little or no consideration.

 

Defenses may include:

• Demonstrating that the transferee acted in good faith and gave value
• Showing legitimate business purposes inconsistent with fraudulent intent

Constructive Fraudulent Transfers (11 U.S.C. Section 548(a)(1)(B))

 

Constructive fraudulent transfer claims do not require proof of actual intent. Instead, they focus on whether the transaction's economic substance harmed creditors.

To establish constructive fraud under Section 548(a)(1)(B), a trustee must show:

• The debtor transferred property or incurred an obligation
• For less than a reasonably equivalent value
• While insolvent, made insolvent by the transfer, or left with unreasonably small capital

Constructive fraud often arises when distressed companies shift assets to affiliates, repay insider loans, or engage in transactions that do not reflect fair value.

 

Defenses typically involve demonstrating:

• That reasonably equivalent value was given
• That the debtor was solvent at the time
• That the transfer served a legitimate business purpose

Post-Petition Transfers (11 U.S.C. Section 549)

 

Once a bankruptcy case is filed, the debtor’s assets become property of the estate, and transfers may only occur with appropriate authorization. Post-petition transfer actions arise when estate assets are transferred without court approval or without an applicable statutory exception.

 

To establish a claim under Section 549, a trustee must show:

• A transfer of estate property
• Made after the commencement of the bankruptcy case
• Without authorization from the court or the Bankruptcy Code

Typical defenses include showing that:

• The transfer was approved by the court
• The transfer was permitted under a first-day order or another statutory exception
• The transaction fell within the ordinary course of business after filing

Why Avoidance Actions Matter for Businesses and Creditors

 

Avoidance actions can have substantial financial implications. For creditors, receiving a demand letter does not necessarily mean repayment is required; many defenses may apply, and fact-specific analysis is essential. For businesses, understanding how transactions will be viewed in a potential bankruptcy can help reduce exposure and avoid costly litigation later.

 

Accurate financial records, documentation of value exchanged, and clarity around the purpose of transactions can significantly influence how avoidance actions unfold.

How Dunn Law, P.A. Can Assist

 

Avoidance actions are a technical but essential part of bankruptcy law. They help ensure fairness among creditors and preserve the estate's value. For businesses, fiduciaries, advisors, and lenders, understanding the risks and available defenses is critical when navigating financially distressed situations.

 

Dunn Law, P.A. represents trustees, assignees, fiduciaries, lenders, and businesses in avoidance litigation arising under federal bankruptcy law and state insolvency statutes. Our team can help evaluate exposure, develop defenses, and guide clients through the strategic and procedural considerations of these claims.

 

If you are facing a potential avoidance action or advising a client who may be at risk, our attorneys are available to help you understand your options and protect your interests.