The Trustee’s Activities: The Chapter 7 Bankruptcy Process

The Trustee’s Activities is part 8 of a 10 part series on Chapter 7 bankruptcy and will provide general information regarding bankruptcy under Chapter 7. 

1. Liquidation

The trustee’s main role is to review the debtor’s schedules for nonexempt assets and, if appropriate, to liquidate those assets. If there are no nonexempt assets, the trustee will docket a Report of No Distribution, or “no asset report,” and take no further action on the case.

The trustee may employ an attorney, appraisers, auctioneers, and other professionals to assist in the liquidation. Liquidation may involve sale of real or personal property, either at private sale or public auction, collection of accounts receivable and other money owed the debtor, and litigating causes of action belonging to the debtor. This last item includes bringing lawsuits for tort or contract claims, or stepping into already pending lawsuits in the name of the debtor's estate.

2. Avoidance actions.

The trustee may also bring certain avoidance actions on behalf of the estate. These are causes of action that specifically arise in bankruptcy, and are designed primarily to insure that no single creditor is favored over other similarly situated creditors. The concept of equivalent distribution to similarly situated creditors is one of the key concepts of the Bankruptcy Code.

There are three main types of avoidance actions:

a. Preference actions--§ 547

A preference is a transfer to a creditor on account of an “antecedent debt” (i.e., a debt predating the payment as opposed to a contemporaneous purchase and sale) that puts that creditor in a more favorable position than other creditors. The payment must be made within 90 days of the date of filing, or within one year in the case of insiders (relatives, partners, corporate officers and affiliates), and while the debtor is insolvent. Insolvency is presumed in the 90 days preceding the date of filing. The creditor must have received more by the payment than it would have received in Chapter 7 if the payment had not been made. This last requirement makes it difficult to make a preferential payment to a priority creditor.

Consumer debtors have sometimes repaid relatives on loans within the year preceding filing, or given them security on a preexisting debt. Those payments and other transfers must be disclosed, and it can be uncomfortable if the trustee starts asking the debtor’s family members to pay back money. Be sure to ask about transfers to relatives and be aware of the preference implications.

There are a number of such transfers that are not deemed preferences, including payments that are below a minimum dollar-amount limit fixed in the statute, payments in the ordinary course of business (e.g., to trade vendors within the normal billing cycle), payments which are a “substantially contemporaneous exchange,” and payments for which new value is given.

The simplest example of a preference would be where the debtor pays an unsecured creditor money on a months-old bill within 90 days of filing. The trustee may then demand that the creditor return the funds to the bankruptcy estate, so that the money may be distributed equally to all creditors. A transfer need not be one of money. A debtor who gives an unsecured creditor a deed of trust in his personal residence, to secure an old debt, has made a preferential transfer.

Nothing aggravates and mystifies creditors more than receiving a letter from the trustee, or worse yet a summons and complaint, demanding return of preferential payments, when the creditor is still owed additional money by the debtor. Nevertheless, unless the payment falls into one of the exceptions, the creditor may have to return the funds received.

b. Fraudulent transfers--§ 548

The trustee may avoid any transfer of an interest of the debtor in property, made within two years of filing, if the debtor (a) made the transfer with the actual intent to hinder, delay, or defraud creditors, or (b) received “less than a reasonably equivalent value in exchange for such transfer,” and was insolvent at the time of the transfer or became insolvent because of the transfer. This is an action both to insure that no creditor receives an unfair advantage and to prevent the debtor from improperly sheltering assets.

The statute prevents actual fraud, by prohibiting transfers with the actual intent to hinder, delay, or defraud creditors; e.g., a quit claim deed of real property with equity, to the debtor’s sibling, for no consideration and to keep it out of the reach of creditors. The statute also prevents “constructive” fraud, by prohibiting transfers for less than reasonably equivalent value. This prevents an insolvent debtor from selling property at distress prices before filing, or gifting property, or paying a relative’s debt. What is reasonably equivalent value is decided on a case-by-case basis.

c. Unauthorized postpetition transactions--§ 549

The trustee may avoid any transfer of property of the bankruptcy estate that occurs after the commencement of the case and is not otherwise authorized. A debtor cannot file a petition and then make payment to any creditor out of assets (such as cash) held at the time of filing. There is a limited exception for certain transfers of real property.

d. Recovery of transfers--§ 550.

Recovery of avoidable transfers may be accomplished through a lawsuit in bankruptcy court, under the original bankruptcy filing, called an “adversary proceeding.” These are discussed below. Recoveries may be had from the initial transferee, any immediate transferee of the initial transferee, or the entity for whose benefit the transfer was made. § 550(a).

3. Lien Avoidance

The trustee is given “strong arm powers,” including the power of a hypothetical judgment lien holder or bona fide purchaser of real property. § 544. This provision enables the trustee to attack and set aside unperfected security interests in both real and personal property. For example, a creditor who loans money to the debtor, and takes a deed of trust in the debtor’s house, but fails to properly record the deed, would be vulnerable under state law to a bona fide purchaser of that house. The trustee steps into the shoes of that hypothetical bona fide purchaser, and the unperfected interest will not survive the bankruptcy filing. These avoidance powers may sometimes be used to invalidate security interests and free up property for liquidation.

The trustee can also avoid certain statutory liens, § 545. These include liens which first become effective upon insolvency or bankruptcy, liens for rent, or liens which are not enforceable against a bona fide purchaser.

Contact the bankruptcy attorneys at Wenokur Riordan PLLC today at (206) 724-0846 to discuss your situation.

This article is intended to provide you with enough detail to give you a good basic understanding of the process, without snowing you under with too much information. Obviously, there are exceptions and nuances to just about everything described in this outline. The Bankruptcy Code, Federal Rules of Bankruptcy Procedure, and reported case law are the primary sources of information. All section references here are to the United States Bankruptcy Code, 11 U.S.C. § 101 et seq. All Rule references are to the Federal Rules of Bankruptcy Procedure.