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Bankruptcy: What does Preferential Payment mean?

Thumbnail image for Thumbnail image for money.jpgCreditors have hounded you for months. Your bills have been piling up, but you have finally saved enough money to pay off one of your debts in full. You feel some relief because you have finally made a step towards getting out of debt. However, something happens and you are forced to file bankruptcy just three months later. Your bankruptcy trustee may now consider the payment you made a preferential payment, because you paid one debt off in full while giving nothing to your other creditors.

When a debtor declares bankruptcy, he or she is not allowed to show preference to any one creditor and must divide their assets equally among all creditors. This means that if a debtor pays one creditor in full (6 months prior to filing bankruptcy if a normal creditor and 1 year if a family member) the creditor may be forced to give the money back to the bankruptcy trustee.

11 U.S.C. ยง 547 defines preference as:

1) The transfer of an interest of the Debtor in property;
2) To or for the benefit of a creditor;
3) For or on account of an antecedent debt owed by the Debtor before such transfer was made;
4) Made while the Debtor was insolvent (the Debtor being presumed to be insolvent within the 90-day period preceding the filing of a petition); and
5) Made within 90 days before the filing of the bankruptcy petition (or within one year if the creditor was an insider);
6) That enables the creditor to receive more than such creditor would have received in the case were a Chapter 7 liquidation proceeding.

In bankruptcy, the creditor’s claims are paid on a ranked basis according to statutes, which dictates who is paid and how much. A pre-filing payment must be paid back to the bankruptcy trustee because a payment made to one creditor over another would be seen as preferential treatment and unfair to the other creditors owed money.

Creditors do have some common defenses to having to give a trustee back a payment from a debtor. Under Section 547 of the bankruptcy code, a preferential payment is made “for or on account of antecedent debt.” Therefore, if a payment is for a new value the debtor’s payment is no longer considered a preferential payment. In order for a creditor to use the defense, the payment can never be applied to a past invoice that involves debt wiped out by the bankruptcy.

Another defense a creditor can use is called the “ordinary course of business” defense. This defense applies to situations where a debt was incurred in the ordinary course of business between two parties, and was paid to the creditor according to the ordinary course of business, or was paid according to the ordinary business terms that are customary to the industry.

A less common defense a creditor may use is called the “subsequent new value” defense. This occurs in an ongoing business relationship when a debtor continues to work during the 90-day period prior to bankruptcy. In this situation a debtor may be able to keep some of the preferential payment.

If you are considering bankruptcy we recommend speaking with an experienced bankruptcy attorney before making any payments to a creditor. Contact the Law Offices of David Goldman. PLLC today for more information on Chapter 7 and Chapter 13 bankruptcies.

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