What is Preferential Payment in Bankruptcy?

  • Bankruptcy

What is Preferential Payment in Bankruptcy?

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People who are struggling with multiple debts often find it difficult to balance them. The general perception is that you should close any many debts possible before you end up filing for bankruptcy. However, Dallas based bankruptcy law firm Recovery Law Group informs that when you file for bankruptcy, payments made to any creditor at the cost of denying other creditors are considered preferential payment. This is because you decided to pay one creditor in full while giving nothing to others.

While filing for bankruptcy, the debtor cannot show any preference to creditors. The assets of the debtor need to be divided equally among all creditors. In case the debtor paid any creditor in full, the bankruptcy trustee might consider it a preferential payment, if the transaction took place 6 months before bankruptcy filing (the normal creditor). If the creditor was a family member, this duration is 1 year.

According to 11 U.S.C. § 547 preference is defined as:

  • Transfer to or for the benefit of a creditor
  • Transfer of interest of the debtor in property
  • Transfer made when the debtor was insolvent (90 days prior to bankruptcy filing)
  • Any transfer made within 90 days (or 1 year in case of family/friend) before the filing of a bankruptcy petition
  • For any debt owed by the debtor prior to the transfer
  • When a creditor receives more than they would have in case of chapter 7 liquidation proceeding

During bankruptcy, claims made by creditors are paid according to statutes which decide who will be paid and how much. The bankruptcy trustee must receive a pre-filing payment since any payment made to one creditor over others is seen as preferential payment and is unfair to other creditors. However, getting a payment back from a creditor is not easy.

Creditors can deny giving back the payment received to the bankruptcy trustees. As per Section 547 of bankruptcy code, preferential payment is done “for or on account of an antecedent debt.” Thus, if the payment is made for any new value, it cannot be considered a preferential payment. Thus, if the creditor does not apply the payment to a past invoice which is regarding a debt having been discharged in bankruptcy, they will not have to reverse the payment to the bankruptcy trustee.

Another line of defense for creditors is available. This is known as the “ordinary course of business” defense where debt was acquired in the normal course of business between two parties and was paid according to the terms of the business. “Subsequent new value” defense is another strategy for creditors to avoid reversing the payments made to them by the debtor. This can take place if the debtor works for 90 days prior to a bankruptcy filing. If the debt is paid as part of an ongoing business relationship and the debtor might keep some preferential payment.

If you are contemplating bankruptcy, it is recommended that you speak with experienced bankruptcy lawyers at 888-297-6023 to know more about the workings of different bankruptcy chapters.