What is a Bankruptcy Preference?

A bankruptcy preference is a transfer made shortly before the case is filed that the trustee can take back from one creditor and share with all the other creditors. The transfer must be of money or property in which the debtor has an interest. It must be made to  a creditor owed money by the debtor. The transfer must be more than the creditor would receive in a Chapter 7 distribution. Finally, it must be made within a certain period of time. 11 USC §547 governs the preference rules under federal law.

The preference period is 90 days before filing unless the debtor has a special relationship with the creditor and is considered an insider. Insiders are close family members, business partners, or a corporation of which the debtor is a person in control such as an officer or director.  The preference period for transfer to an insider is expanded by law to one year instead of 90 days.

There are some financial limits on the trustee’s ability to recover a preferential transfer.  If more than half the debts in the case were incurred by an individual primarily for a personal, family, or household purpose it is considered a consumer case.  Trustees can recover a preferential payment in a consumer case if the total amount of all preferences is more than $600 in that case.  If the case is not a consumer case, preferences must total more than $5,850 before the trustee can recover them.

Congress permits the trustee to recover preferences to discourage creditors from taking more than their fair share from the debtor just before a case is filed. The law is intended to promote an equal distribution of the debtor’s assets. It also prevents the debtor from picking and choosing which creditors to pay.

Bankruptcy trustees are paid a commission on the money they collect for the estate. For this reason they are eager to recover preferential transfers for the bankruptcy estate. Some trustees are lawyers and represent themselves before the court. Lawyer trustees can pay themselves fees for legal work in recovering a preference. In this way, the trustee can be paid both legal fees for recovering the preference and a commission for handling the money.

Many consumers borrow from friends and family to make ends meet when they run out of money.  If a friend is repaid a loan within 90 days or a family member is repaid within one year before filing, the payment may be determined to be a preference and subject to recovery by the trustee.