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Bankruptcy in Brief              a service of the Moran Law Group

 

Home/ Creditor rights/ Preferences

Preferences

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 in bankruptcy.

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 between creditors. 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 bankruptcy.

Is it a preference?

    Bankruptcy Code §547 defines a preference as

1. Payment on an antecedent (as opposed to current) debt;

2. Made while the debtor was insolvent;

3. To a non insider creditor, within 90 days of the filing of the bankruptcy;

4. 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 bankruptcy. 

Defenses to preference actions

Defenses to the recovery of a preference are found in 11 U.S.C. 547(c).  They include:

• 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 debtor.
• amounts of subsequent credit extended and unpaid.

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 these defenses.'

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.

Insider preferences

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. 

  Bankruptcy planning and preferences

     1/18/05