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A preferential transfer occurs when an insolvent person pays off a creditor within the period preceding a bankruptcy filing. The payment can be to settle a family loan or other debt, typically within 90 days before a bankruptcy filing.
Regarding family and insiders, the look-back period can extend to the 12 months preceding the filing. Under 11 USC § 101(31), the court-appointed trustee may file an avoidance suit to return the assets to secured creditors in order of precedence determined by the court.
Five Elements Define Preferential Transfers
When the court examines a bankruptcy filing, they will look back through financial statements and information for transactions occurring during the 90 days before the filing. When the trustee sees a questionable transaction, they weigh it against these five elements necessary to qualify it as a preferential transfer:
- The transfer benefits the creditor.
- The transfer was for a debt owed before it was made.
- Transfer of funds happened while the debtor was considered insolvent.
- The transfer occurred within 90 days of the filing (or within 12 months if the creditor was an insider).
- The transfer enabled the creditor to receive more than they would be allotted through the bankruptcy estate liquidation process.
If a transaction meets all five elements listed above, the trustee may attempt to retrieve the assets from the creditor using a clawback suit. Preferential transfers can be interpreted as an attempt to hide assets and can harm your bankruptcy case outcome.
Payments Not Considered Preferential Transfers
Occasionally, a transaction that seems like a preferential transfer may appear on the look-back analysis but needs further explanation. The trustee will examine your monthly payments, such as car notes, mortgage payments, vehicle insurance, and utilities. These are allowable expenses. The trustee is looking for payments that are outside of your regular bill-paying activity.
Understanding the Preferential Payment Rule
Per 11 USC § 547, the court must establish an order for creditor payment during a bankruptcy. The code specifies that creditors on equal grounds with similar claims should not have a preference over one another. As the court reviews each of your creditors, they are ranked in a scheduled order for payment resulting from the liquidation of assets.
When a payment to a creditor occurs out of order established under the bankruptcy code, it might be considered a preferential payment. The trustee may file a demand letter requesting the return of the funds. If the creditor refuses, they might be subject to an avoidance suit filed by the trustee. An investigation will occur, and if deemed a preference payment, the assets must be returned to the court.
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Defending Against Preferential Payment Penalties
A business can defend against a preference claim in several ways. By presenting evidence that may not appear during a review of financial records alone, a creditor may validate a payment as non-preferential.
In each case, the trustee will gather the evidence and decide based on the rules outlined within the bankruptcy code.
The Look-Back Period for Insider Creditors vs. Regular Creditors
The standard look-back period for bankruptcy is 90 days. The court will review your financial records for the past three months. In some bankruptcy cases with insider creditors, the look-back period is 12 months.
Under 11 USC § 101(31), insiders are defined as:
- Family and friends
- General business partners of the debtor
- Any partnership where the debtor is a general partner
- Any corporation where the debtor is a board member or in a position of control
The purpose of the extended look-back period for insiders is that people are more inclined to favor paying back Aunt Susie than they are regular creditors.
What Is an Avoidance Lawsuit?
The bankruptcy trustee can file an avoidance lawsuit when preferential transfers are identified. The lawsuit aims to force the party who received the preferential transfer to return the assets so they may be distributed to creditors following bankruptcy laws.
A Bankruptcy Lawyer Can Help You Organize Your Debts
If you have overwhelming debt, a bankruptcy attorney from Farmer & Morris Law, PLLC, can help. Our team of knowledgeable legal representatives can help you guide through the entire process. The first step is determining what Chapter to file under, organizing your documentation, and presenting your case to the court.
Our bankruptcy team offers a free case evaluation. We will listen to you, help you understand the process, and guide you on your next steps. Contact our bankruptcy team if you are ready to begin your path to a fresh financial start.
