a service of the Moran Law Group
The Bankruptcy Code permits a trustee
(or a debtor in possession)
to recover from creditors payments made shortly before the bankruptcy
filing where the payment gave the creditor more than other, similarly
situated, creditors would get through the bankruptcy process.
The policy behind the statute is to diminish the advantages
that a creditor might get by litigation or by aggressive collection
actions that force the debtor into bankruptcy. That is accomplished
by making payments received in the 90 days before the filing recoverable
It is neither wrong (under California law) of the debtor
to make a preferential payment nor wrong of a creditor to accept it
. The preference statutes are simply an attempt to achieve equity
Creditors are almost always better off attempting
to get payment of their claims from their debtors and dealing with any
efforts to recover the money when, and if, such attempts are made in
Is it a preference?
Bankruptcy Code §547 defines
a preference as
Payment on an antecedent (as opposed to current)
Made while the debtor was insolvent;
To a non insider creditor, within 90 days of the
filing of the bankruptcy;
That allows the creditor to receive more on its
claim than it would have, had the payment not been made and the
claim paid through the bankruptcy proceeding.
Note that payments to a fully secured creditor aren't
preferences because the creditor didn't get more than he would have
in bankruptcy, where the creditor would get the value of the collateral.
A non obvious preference may occur when the creditor converts
an unsecured debt to a secured
debt by recording a financing statement long after the transaction with
which it was associated; by obtaining a writ of attachment; or by recording
a judgment lien.
Creditors are best served by the prompt perfection of
such liens to lessen the possibility that the advantage obtained by
getting the lien is lost in a preference recovery action in a subsequent
Defenses to preference actions
Defenses to the recovery of a preference are found in
547(c). They include:
These defenses need to be raised in an answer to a preference complaint.
The burden of proof lies with the creditor to establish that despite the
elements of a preference, the transfer is protected by one or more of
- contemporaneous exchanges;
- payments made in the ordinary course of the business of the debtor
and the creditor on ordinary business terms; and
- security interests that secure debts that bring new value to the
- amounts of subsequent credit extended and unpaid.
The trend today seems to be for trustees or debtors in
possession to sue everyone who received payment of any sort during the
90 days before filing and to sort out the merits of the plaintiff's
claims later. It feels a lot like extortion since the economics frequently
suggest the settlement of claims that appear to have little validity.
The bankruptcy code also permits the recovery of payments
on old claims owed to insiders, such as relatives, corporate officers
or directors, or related entities. For insiders, the trustee can
look back to payments made within a year of the bankruptcy filing.
This provision attempts to prevent the debtor from paying relatives
and business decision makers at the expense of the trade creditors.
In an insider preference action, there is no presumption
that the debtor was insolvent when the payment was made and thus the
proof of these kinds of actions is sometimes more complex for the trustee.