Bankruptcy Preference Payments to Creditors

A bankruptcy preference payment happens when you make a pre-bankruptcy payment to a creditor that is more than the creditor would have received in your bankruptcy case. Preference payments unfairly funnel most of a filer's money to a creditor of choice, leaving less to pay everyone else in the case. To prevent unfairness, the bankruptcy trustee administering your case can void the payment and "claw back" the money or property from whoever received it. (11 U.S.C. § 547.)

Not every payment made before bankruptcy qualifies as a preference, though, and clawback actions don't happen often. Even when they do, they're fairly simple to navigate once you know:

• what constitutes a preferential transfer
• how long the bankruptcy preference period lasts
• which payment amounts you must report
• what defenses can protect a payment from being clawed back, and
• how the bankruptcy trustee goes about avoiding a preference payment.

How Long Is the Bankruptcy Preference Period?

The bankruptcy preference period is 90 days before your filing for most creditor payments, and one year for payments made to a creditor who qualifies as an "insider." The following people and entities count as insiders:

• a relative
• a general partner
• relatives of a general partner
• a partnership if you're a general partner
• a corporation if you're an officer, director, or person in control, or if you own more than 20% of the voting securities, or
• a managing agent of any company, including a sole proprietorship.

Why does the insider period run a full year instead of 90 days? Because the code defines "insider" broadly, so the trustee can look back further at money that moved between you and people or entities close to you. (11 U.S.C. § 101(31).)

What Preference Payments Must You Report?

You must report potential preference payments made to creditors before bankruptcy, and what you disclose depends on whether you're a business or an individual filer. An individual filer's debts are primarily "consumer" debts incurred for personal and household expenses, while most of a business filer's debts come from a profit-generating enterprise.

Here are the specific reporting rules:

• Payments during the year before filing. All filers report payments made to insider creditors, regardless of the amount.
• Payments during the 90 days before filing. Individual filers report payments totaling $600 or more to any single creditor, and business filers report payments to any single creditor totaling $8,575 or more.

The $600 figure is fixed by statute and has no update schedule. The $8,575 threshold is valid from April 1, 2025, through March 31, 2028. (11 U.S.C. § 547(c)(8)-(9).)

Will Rent and Other Household Expenses Count as a Preferential Payment?

No. The trustee won't unwind payments for basic living expenses, such as normal and usual mortgage or car loan payments, or court-ordered support payments. That said, you won't want to pay rent, utility bills, support payments, or any other obligation months in advance. The trustee will likely recover any amount paid over and above what was currently due, and might even suspect fraud if it looks like you were trying to hide money from creditors.

What Defenses Exist to a Bankruptcy Preference Claim?

The bankruptcy code gives creditors a few defenses against a preference claim, including:

• Ordinary course of business. The payment was made and received in the ordinary course of business or financial affairs of the debtor and creditor, and according to ordinary business terms.
• Contemporaneous exchange for new value. The debtor and creditor intended the payment as a contemporaneous exchange for new value, such as paying cash for goods delivered at the same time.
• Subsequent new value. After receiving the payment, the creditor gave the debtor new value, such as additional goods or services, without the debtor making another payment.

These defenses come up most often in business bankruptcies, where creditors have the resources to litigate a preference claim. (11 U.S.C. § 547(c).)

As an individual filer, you generally won't be the one raising a defense because the creditor, not you, is the target of a clawback action. You also must be insolvent, meaning your debts exceed your assets, before the preference rules apply at all, and most people are already insolvent well before they file.

So unless the trustee is asking for the return of funds that don't qualify as a preferential transfer, or you had a very sudden and unexpected financial downturn, you're unlikely to have much of a defense yourself. Every case is unique, though, so it's worth discussing your situation with a knowledgeable bankruptcy lawyer.

What Happens If You Make a Preference Payment?

The bankruptcy trustee will first try to resolve the issue informally by asking the creditor to return the funds. If that doesn't work, the trustee or another creditor can bring an action in bankruptcy court asking the judge to require the creditor to return the funds. As the debtor, you must cooperate with the trustee, but you won't be pursued for the money owed or required to make an effort to recover it from the creditor yourself.

How Does the Bankruptcy Trustee Find Preference Payments?

The trustee finds preference payments by reviewing what you report in your bankruptcy paperwork. Checking your disclosures for potential preference payment rule violations is one of the trustee's core responsibilities. If the trustee finds one, they'll instruct the creditor to return the preferred funds or property.

What Happens When the Trustee Targets a Preference Payment to a Family Member?

A preference claim can feel personal when the trustee goes after a relative or someone close to you instead of a regular creditor, since these payments fall under the longer, one-year insider lookback period. Here's what this might look like.

Suppose you borrow $1,500 from your brother to pay for a car repair. You later receive a tax refund and repay your brother the $1,500. Six months later, you file for bankruptcy. The bankruptcy trustee will want to get the $1,500 from your brother, add it to your bankruptcy estate, and distribute it to all of your unsecured creditors.

If you're facing this situation, you have several options:

• Wait to file for bankruptcy until the one-year period has expired.
• Ask your bankruptcy lawyer whether the trustee will let you reimburse the bankruptcy estate for the payment amount.
• Let the trustee collect from your brother and reimburse him with income or assets that aren't part of the bankruptcy estate.

What Other Asset Transfers Can a Bankruptcy Trustee Unwind?

Beyond preference payments, the trustee can unwind other transfers of money and property you made before filing, but the lookback period depends on the transfer type.

• Gifts and below-value sales. The trustee can recover gifts of cash or property, and transactions in which it appears you sold an asset for less than its value, going back two years before you filed.
• Transfers to a self-settled trust. If you transferred property into a trust or similar asset-protection device that you benefit from, the trustee can look back ten years. (11 U.S.C. § 548(e).)

You'll find these disclosure periods broken out in the Statement of Financial Affairs for Individuals Filing for Bankruptcy form: gifts over $600 and other property transfers or undervalue sales appear in Questions 13 and 18 with a two-year lookback, while transfers to a self-settled trust appear separately in Question 19 with a ten-year lookback.

How to Avoid a Preference Payment Problem

The best way to avoid a clawback headache is to talk with a bankruptcy lawyer before you pay any single creditor a significant amount in the months leading up to filing. A lawyer can review your payment history, flag likely preference issues, and help you time your filing or adjust your payments so you don't end up unwinding money you've already parted with. Once you know what to expect, you'll be in a strong position to decide whether filing for bankruptcy now or later is in your best interest.

For more on this topic, try The Clawback Provision and Preferential Transfers.