In a bankruptcy case, the debtor in possession or the trustee has certain “avoiding” powers. These avoiding powers are exercised to cancel a transfer of money or real property made during a certain period of time prior to the submission of the bankruptcy petition. Section 547 of the US bankruptcy code allows a debtor in bankruptcy or its trustee to force repayment of certain transfers completed within 90 days of a bankruptcy filing. The time frame is extended up to one year if the transferee was an insider such as relatives, general partners, and directors or officers of the debtor. These transfers are usually recognized as preferences or preference payments.
To avoid such a particular transfer of property, the debtor in possession can terminate the transaction and force the return or disgorgement of the payments or real property, which then can make available to disburse all creditors. Generally, the liability of the transferee is enforced by a court order initiated either by the debtor or the bankruptcy trustee against the preference creditors. Under the bankruptcy code, these transfers are referred as avoidable transfers. Moreover, section 544 of the US bankruptcy code enables the bankruptcy trustee to avoid transfers under applicable state law. Sometimes, such state laws provides for longer time periods to cancel a transfer of money or real property.
The avoidable or preference rule recognizes that the bankruptcy debtor can disburse certain limited creditor obligations. This rule was developed to promote the equality distribution principle among creditors. The avoidable or preference rule involves seven elements. They are:
- It must be a transfer;
- It must be a real property of the debtor;
- It must be to or for the benefit of a creditor ;
- It must be meant to settle an account of a former debt;
- It must be made during the insolvency of the debtor;
- It must be a made within 90 days of bankruptcy or one year in the case of an insider; and
- It must enable the creditor to avail more than that of a Chapter 7 liquidation process.