Legal Definitions - avoiding power

Avoiding power refers to the legal authority, primarily exercised by a bankruptcy trustee, to cancel or "undo" certain financial transactions that occurred before a bankruptcy case was filed. The main goal is to recover assets that were improperly transferred away from the debtor, ensuring that these assets can be distributed fairly among all creditors. This power prevents debtors from unfairly favoring certain creditors or hiding assets just before bankruptcy.

Here are some examples illustrating avoiding power:

• Example 1: Preferential Payment

  A small business, facing imminent bankruptcy, pays off a $15,000 debt to its owner's sibling a month before filing for Chapter 7 bankruptcy. Other creditors, such as suppliers and landlords, remain unpaid.

  How it illustrates avoiding power: The bankruptcy trustee would use their avoiding power to "avoid" this $15,000 payment. This means the sibling would have to return the money to the bankruptcy estate. The trustee would then add this money to the pool of assets available to be distributed proportionally among *all* creditors, not just the favored one. This prevents the debtor from giving preferential treatment to certain creditors over others shortly before bankruptcy.

• Example 2: Fraudulent Transfer (Asset Hiding)

  An individual, anticipating a large lawsuit judgment and potential bankruptcy, gifts their valuable vintage car collection to a distant relative for free, just two months before filing for Chapter 7 bankruptcy.

  How it illustrates avoiding power: The bankruptcy trustee would likely invoke avoiding power to "avoid" this transfer as a fraudulent transfer. Since the car collection was given away for no value (or "less than reasonably equivalent value") with the intent to keep it from creditors, the trustee can demand the relative return the collection to the bankruptcy estate. The cars can then be sold, and the proceeds used to pay the debtor's creditors.

• Example 3: Fraudulent Transfer (Undervalued Sale to Insider)

  A struggling manufacturing company sells a piece of specialized machinery, valued at $750,000, to a newly formed company owned by its CEO's spouse for only $100,000, three months before filing for Chapter 11 bankruptcy.

  How it illustrates avoiding power: In this Chapter 11 case, the debtor-in-possession (acting with the powers of a trustee) or a court-appointed trustee would use avoiding power to challenge this transaction. This is a fraudulent transfer because the machinery was sold for significantly less than its true market value to an insider, thereby depleting the company's assets that should have been available to creditors. The trustee could recover the machinery or the difference in value for the bankruptcy estate, ensuring more assets are available for distribution to all creditors.