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What Is the Strong-Arm Clause?

strong arm clause.jpgThe United States Bankruptcy Code includes a 'strong-arm clause' which gives a bankruptcy trustee or debtor in possession (DIP) important powers. Known as avoidance powers, they can give the trustee or DIP the authority to resist certain creditor claims. This most frequently occurs when a company enters into an agreement with a creditor immediately before the company enters bankruptcy. While those pre-bankruptcy agreements are still enforceable against the debtor company, they will need to be considered within the context of the claims of competing creditors.

The Purpose of the Strong-arm Clause

On a certain level, the bankruptcy trustee and the DIP must provide protection for creditors. In their role, they have a legal responsibility to ensure that creditors are treated equitably. Trustees and DIPs are given avoidance powers, under the strong-arm statute, as a tool in order to ensure that creditor claims are handled appropriately. Specifically, avoidance powers will ensure that no creditors have jumped out of line in front of other creditors who have an equal or superior preference. Any transaction or agreement between a creditor and a company that was made immediately before that company went into bankruptcy will always be suspect. Most often, the strong-arm clause is used to deal with unperfected liens, real property transfers or unsecured creditors. Ultimately, the bankruptcy trustee or DIP may decide to set aside a creditor's collection rights in certain circumstance. However, this can only be done using the avoidance powers if it can be justified for the greater collective good of the creditors. Specifically, the avoidance power allows a bankruptcy trustee to:

  • Avoid the dismembering of the debtor company by removing the incentive to take harsh action immediately before an imminent bankruptcy;
  • Facilitate a fair and equitable distribution of the debtor company's remaining assets; and
  • Discourage creditors from taking any secret liens against the company.

Creditors Must Protect Their Preference Rights

All creditors must ensure that their preference rights are fully protected. In some cases, the action of a trustee will help protect preference rights, but in other cases, an over aggressive trustee or DIP may actually try to suppress a creditor's legitimate and fair claim. In many bankruptcy cases, there is simply not enough in the way of remaining assets to allow every party to be paid in full. This makes the preference of your claim extremely important. If your claim is unfairly suppressed, or if another creditor unfairly jumps ahead of you, you could lose out on your ability to collect anything at all. Creditors must take proactive steps to ensure that their rights are adequately protected.

Contact Our Office Today

At Diemer, Whitman & Cardosi, LLP, our skilled San Jose creditors rights attorneys have extensive experience protecting the rights of creditors. If you are California creditor involved in any type of legal action, and you believe that the strong-arm statute is an issue in your claim, please contact our creditors' rights attorneys today to schedule a free evaluation of your case. We serve clients throughout Northern California, including in San Jose and San Francisco.



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