How To Defend Against Bankruptcy Avoidance Actions

Businesses that work with financially distressed companies often focus on getting paid. But sometimes getting paid can create an entirely new problem. Months after a payment is received, a bankruptcy trustee or debtor may come back and demand the money be returned through what is known as a ‘bankruptcy avoidance action.’

These claims can surprise vendors, lenders, professional service providers, investors, and even ordinary customers. A company that thought it successfully navigated a customer bankruptcy may suddenly face litigation demanding repayment of transfers made before the bankruptcy filing.

Avoidance actions are common in large Chapter 11 cases, but they also appear in smaller business bankruptcies, receiverships, and insolvency proceedings. Understanding how these claims work and the defenses available can make a significant difference for companies facing litigation exposure.

What Is a Bankruptcy Avoidance Action?

According to Sean Williams of Levenfeld Perlstein an avoidance action is typically brought by the estate or a representative of the estate to clawback funds that were previously provided by the debtor prior to the bankruptcy being filed.

These claims usually arise under Chapter 5 of the Bankruptcy Code and commonly involve preferential transfers, fraudulent transfers, and unauthorized post-petition transfers. The legal theory behind these claims is fairness. Bankruptcy law attempts to ensure similarly situated creditors are treated equally, rather than allowing certain creditors or insiders to receive preferential treatment before a bankruptcy filing.

Preferential Transfers

Preference claims are among the most common lawsuits filed after a bankruptcy case begins.

Jordan Leu of King & Spalding explains that preferential transfer claims are designed to recover payments on a debt that were made within a defined period of time before the bankruptcy, while the payor (the debtor) was insolvent.

In most cases, the relevant lookback period is 90 days before the bankruptcy filing for ordinary creditors and one year for insiders.

To succeed on a preference claim, a plaintiff generally must show that:

• A transfer occurred within the statutory lookback period
• The transfer involved property of the debtor
• The transfer benefited a creditor
• The transfer was made on account of antecedent debt
• The debtor was insolvent at the time
• The creditor received more than it would have received in a Chapter 7 liquidation

Unlike fraud claims, preference actions generally do not require wrongdoing by the creditor. A vendor may have done nothing improper and still face liability.

Fraudulent Transfers

Fraudulent transfer claims are different from preference actions. Instead of focusing on equal treatment among creditors, fraudulent transfer claims focus on whether the debtor improperly transferred value away from the estate.

Fraudulent transfers generally fall into two categories: actual fraudulent transfers and constructive fraudulent transfers.

• Actual fraudulent transfers involve transfers made with the intent to hinder, delay, or defraud creditors. Because direct evidence of intent is rare, courts usually rely on ‘badges of fraud,’ including transfers to insiders, concealment of transfers, lack of reasonably equivalent value, or transfers made shortly before litigation or bankruptcy.
• Constructive fraudulent transfer claims do not require proof of bad intent. Instead, plaintiffs typically argue that the debtor was insolvent or financially distressed and did not receive reasonably equivalent value in exchange for the transfer.

These claims commonly arise in leveraged buyouts, private equity transactions, asset sales, insider transactions, Ponzi scheme litigation, and cryptocurrency insolvencies.

Unauthorized Post-Petition Transfers

Unauthorized post-petition transfer claims involve transfers made after a bankruptcy case has been filed. Once a bankruptcy petition is filed, the debtor’s assets become property of the bankruptcy estate, and the Bankruptcy Code imposes strict limitations on how those assets may be used.

Unlike preference or fraudulent transfer claims, post-petition transfer claims do not focus primarily on solvency or reasonably equivalent value. Instead, the central question is whether the transfer was properly authorized.

Examples of unauthorized post-petition transfers may include:

• Payments to vendors outside approved ordinary-course procedures
• Unauthorized insider compensation
• Transfers of collateral without court approval
• Unauthorized cryptocurrency transfers
• Improper cash management transactions
• Transfers made in violation of financing orders or cash collateral orders

In Chapter 11 cases, debtors are often allowed to continue ordinary business operations under court supervision. However, transactions outside the ordinary course of business generally require notice and court approval.

These claims frequently arise when:

• A distressed company rapidly loses operational control
• Financial records are incomplete
• Management attempts to favor certain creditors after filing
• Digital assets are transferred without authorization
• Insiders attempt to move assets before a trustee or creditors’ committee gains oversight

Common Defenses to Avoidance Actions

According to Thaddeus Wilson of King & Spalding, avoidance defendants can include a surprisingly broad range of parties. John Levitske of HKA Global LLC  adds that many defendants never expect to become part of a bankruptcy proceeding in the first place.

Common defendants include vendors, suppliers, lenders, law firms, accounting firms, investors, directors and officers, shareholders, guarantors, and cryptocurrency account holders. Although bankruptcy avoidance actions can create significant exposure for defendants, they do have several strong defenses available depending on the type of claim asserted.

Preferential Transfer Claim Defenses

The most common defense to a preferential transfer claim is the ‘ordinary course of business defense.’ This defense applies when payments were made in a manner consistent with the parties’ historical business relationship or industry standards.

Another important defense is the ‘subsequent new value defense,’ which applies when the creditor continued providing goods or services to the debtor after receiving the alleged preference payment. Bankruptcy law encourages vendors to continue doing business with distressed companies, and this defense reflects that policy.

Fraudulent Transfer Claim Defenses

Fraudulent transfer defenses typically focus on disproving one or more required elements of the claim. Common defenses include showing that the debtor received ‘reasonably equivalent value’ in exchange for the transfer or proving that the debtor was solvent at the time of the transaction.

Defendants may also argue that the transaction was conducted in good faith and for legitimate business purposes. In actual fraudulent transfer cases, defendants often challenge whether there was any intent to hinder, delay, or defraud creditors.

Because these disputes frequently involve complex financial analysis, valuation experts are often retained to evaluate solvency, asset values, and the economic substance of the transaction. These questions are often highly technical. Courts may evaluate whether the debtor had sufficient assets to cover liabilities, whether the debtor could pay debts as they became due, and whether the debtor had adequate capital to continue operating.

Unauthorized Post-Petition Transfer Claim Defenses

Common defenses to unauthorized post-petition transfer claims include demonstrating that:

• The transfer was authorized by the Bankruptcy Code
• The transfer was approved by the bankruptcy court
• The transaction occurred in the ordinary course of business
• The defendant provided post-petition value to the bankruptcy estate

In some cases, defendants may also assert good-faith defenses, particularly where they reasonably believed the transaction had been properly approved under existing court orders or cash collateral arrangements.

Practical Steps To Reduce Risk

Companies doing business with distressed entities can reduce avoidance exposure through careful planning.

Practical steps include:

• Maintaining ordinary payment practices
• Carefully documenting transactions
• Monitoring financial distress indicators
• Considering properly perfected security arrangements
• Evaluating settlement opportunities early
• Consulting bankruptcy counsel before disputes escalate

To learn more about this topic view Defending Against Bankruptcy Avoidance Actions. The quoted remarks referenced in this article were made either during this webinar or shortly thereafter during post-webinar interviews with the panelists. Readers may also be interested to read other articles on Chapter 5 Causes of Action.

This article was originally published on June 4, 2026.

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