What Is a Preference in Bankruptcy?

Wasson and ThornhillBankruptcy Law

What Is a Preference in Bankruptcy?

A preference is a payment you make to a creditor before you file bankruptcy that your trustee may make the creditor pay back to the trustee.

 

What’s a Preference in Bankruptcy?

Preference law allows a bankruptcy trustee to require a creditor that you paid during a certain period of time before you file bankruptcy, under certain conditions, to pay that money “back” to the trustee. The creditor you paid, voluntarily or not, would have to give up that money. The trustee would then take and divvy up the money among all the creditors. Your creditor may or may not get any of that distributed money. It would usually get either none or just a small percentage of what it had to give up.

Section 547(b) of the U.S. Bankruptcy Code lays out the 5 elements of a preference. It’s a payment paid or asset transferred:

  1. to a creditor
  2. for a debt owed before that payment was paid or transfer was made
  3. made while the debtor was insolvent
  4. during the 90 days before filing bankruptcy—or during the year before filing for special creditors
  5. that gave the creditor more that it would have received in a distribution in a Chapter 7 liquidation at the time of the payment or transfer.

More about these elements in the next couple of blog posts.

The Purpose of Preference Law

What could be the point of all this? Why make a creditor who you paid before filing bankruptcy have to pay that same amount of money back, but to your trustee, after you file bankruptcy?

First, preference law discourages creditors from being overly aggressive in collecting debts. Instead of fighting to get the last dollar out of a debtor, they may work more cooperatively. Otherwise if they force a debtor into bankruptcy they could lose the money collected. Less aggressive creditors may result in less debtors filing bankruptcy. Creditors have a disincentive to pushing debtors into bankruptcy if they know that any money they get on the brink of bankruptcy may have to be turned over the bankruptcy trustee.

Second, preference law discourages debtors in financial trouble from paying only one special creditor to the detriment of their remaining creditors. You may hesitate to pay a favorite creditor before bankruptcy if that creditor would just have to “return” it to your trustee later.

Both of these promote one of the most important principles of bankruptcy law. That’s the fair and equal treatment of creditors—no favoritism for any particular creditor(s). Preference law intends to discourage behaviors favoring a select creditor or two shortly before a bankruptcy filing. Both an aggressive creditor and a favorite-paying debtor result in a debtor’s very limited money going to a select creditor.

How Can Bankruptcy Affect a Payment Paid BEFORE You Filed Bankruptcy?

How can bankruptcy law unwind payments that you made before filing the bankruptcy case? Bankruptcy does mostly focus on your financial condition at the time you file your case with the the help of your Louisville bankruptcy lawyer. (As well as after you file your case under Chapter 13.) But it also does have the power to look backwards in time to address certain perceived abuses that may occur. This preference law is one example.

Good and Bad Preferences

In our first sentence above we said that a preference is sometimes good and sometimes not. Having your bankruptcy trustee get back a payment you paid to a creditor may be good. It would be good if you don’t mind the trustee undoing that creditor’s payment and perhaps putting that money to better use. It would be bad if the trustee was making a creditor return a payment that you’d prefer that creditor to keep.

Let’s look at these two kinds of preferences in our upcoming blog posts.