Bankruptcy Basics – Preferences

The Bankruptcy Code permits a trustee to recover from creditors payments made shortly before the bankruptcy filing, where the payment gave the creditor more than other creditors in a similar position would get through the bankruptcy process.

The policy behind the statute is to reduce the advantages that a creditor might get by suing or by collection activities that force the debtor into bankruptcy. That is accomplished by making payments received in the 90 days before the filing recoverable in bankruptcy by the trustee.

It is neither wrong for the debtor to make a preferential payment, nor is it wrong for a creditor to accept such payment. The preference statutes are simply an attempt to achieve equity between creditors.

Bankruptcy Code ยง547 defines a preference as:

  1. Payment on an antecedent (as opposed to current) debt;
  2. Made while the debtor was insolvent;
  3. To a non-insider creditor, within 90 days of the filing of the bankruptcy;
  4. That allows the creditor to receive more on its claim than it would have, had the payment not been made and the claim paid through the bankruptcy proceeding.

Any payments to a fully secured creditor are not usually preferences, because the creditor would not get more than he would have in bankruptcy, where the creditor would get the value of the collateral.

While the look back period for preferences is usually 90 days, the bankruptcy code also permits the recovery of payments on claims owed to insiders, such as relatives, friends, corporate officers or directors, or related entities, made within 1 year of the bankruptcy filing. This provision attempts to prevent the debtor from paying relatives, friends and business decision makers at the expense of other creditors.

Preference recovery is generally a matter between the trustee and a creditor. When the creditor is a third party, the debtor may not care very much. When the creditor in question is a relative or a friend, however, most debtors are very concerned. If a bankruptcy case is filed within a year of these payments to relatives and friends, the trustee may take the money from the friend or relative the debtor paid, and redistribute it to creditors in accordance with the bankruptcy laws.

There are some procedural issues that apply to preferences. For example, a payment made by check is effective as of the date the check cleared, not the date on the check or the date it was mailed. There are also some defenses to preferences, usually available in a business rather than a consumer setting. Preferences can be voluntary payments, like a check sent in payment of an invoice, or involuntary, like attaching a bank account.

A debtor needs someone with knowledge and experience in these issue on his side. One of the most valuable things an experienced bankruptcy attorney can do is prevent problems for you, and unintended consequences for your family members or business partners. It is also best to seek such advice before you make that payment, or transfer that asset. Lawyers can control damage in most situations, but we prefer to prevent a problem arising in the first place and this can be accomplished in most situation with pre-bankruptcy planning.

If you are dealing with debt problems in Rochester, New York; Canandaigua, Brighton, Pittsford, Penfield, Perinton, Fairport, Webster, Victor, Farmington, Greece, Gates, Hilton, Parma, Brockport, Spencerport, LeRoy, Chili, Churchville, Monroe County, Ontario County, Wayne County, Orleans County, Livingston County, and being harassed by bill collectors, and would like to know more about how bankruptcy may be able to help you, contact me today by phone or email to schedule a FREE initial consultation.