What is a Strong Arm Clause in Bankruptcy Code?
The Strong Arm Clause, known formally as Section 544 of the Bankruptcy Code, gives the rights of a secured creditor to the bankruptcy trustee. This clause is in place to enable the trustee to avoid transfers or responsibilities for the benefit of the debtor’s creditors that an unsecured creditor might have avoided under nonbankruptcy law if such a creditor exists. In most cases, this helps the trustee to prevent liens that haven’t been finalized and fraudulent transfers.
The entire clause is set out in Section 544, which states “[t]he trustee shall have, as of the commencement of the case, and without regard to any knowledge of the trustee or of any creditor, the rights and powers of, or may avoid any transfer of property of the debtor or any obligation incurred by the debtor” which might have been prevented by certain judicial lien holders or bona fide purchasers. The entirety of the Bankruptsy code can be perplexing and daunting to read through, and it is advisable to get the help of a lawyer to sort through it.
A trustee may act to avoid making certain transfers with their “strong arm” abilities. Here are a few examples of these transfers:
- Unperfected Security Interests — Because of the trustee’s strong arm power, any lien can be avoided as long as it is unperfected at the time the borrower enters bankruptcy. Meaning, the would-be lien holder loses their lien claim, as well as their secured creditor status and privileges in the bankruptcy process. As a result, it’s vital for all lienholders to make sure their security interests are properly perfected according to state law.
- Fraudulent Transfers — The trustee can avoid fraudulent transfers under state law by using Section 544 of the Bankruptcy Code. The Uniform Voidable Transactions Act (UVTA) has been enacted by several states, including California, and allows for the cancellation of transactions that are determined to be either actually fraudulent or constructively fraudulent. The trustee must establish the existence of a creditor who might have filed a fraudulent transfer action at the time the debtor’s petition was filed in order to sustain an action under Section 544 of the UVTA. The avoided transfer, however, is avoided for the advantage of all creditors.
- Transfers in Contravention of State Law — The strong arm authority of a trustee can be used to prevent a number of other transfers that violate state law, such as stock redemptions and transfers of corporate assets in violation of state corporation law.
Creditors Handling Bankruptcy Claims
The Bankruptcy Code gives the bankruptcy trustee various ways to acquire and distribute assets for the benefit of creditors, one of which is Section 544 of the Bankruptcy Code’s “strong arm” provision. It’s vital for creditors to understand their rights and risks if a debtor files for bankruptcy.
While the Bankruptcy Code gives the trustee special abilites to avoid certain transfers, these powers have bounds, and there are a number of defenses to an avoidance action under Section 544, including statutes of limitations, state recording laws, including those that provide for constructive notice, and other curative statutes.