In bankruptcy, a preference payment occurs when you repay a creditor within a certain period of time before you file for bankruptcy. If you make a preference payment (also called a preferential transfer), your bankruptcy trustee may be able to get the money back from the person or business you paid – called "avoiding" the transfer. Not every prebankruptcy payment qualifies as a preference, however. Read on to learn what payments will be considered to be preferential transfers and how the bankruptcy trustee gets the money back.
(To learn more about issues to consider before you file for bankruptcy, visit our Prebankruptcy Planning topic page.)
Essentially, a preference is when a debtor treats one or several creditors better than all of the other creditors as a whole. A prebankruptcy payment is presumed to be a preference in several situations. Generally, you must be insolvent for the below rules to apply (you are insolvent if your debts are greater than your assets):
If you are insolvent (your debts are greater than your assets at the time of the transfer) and you pay a regular creditor an amount of $600 or more (in the aggregate – so this could consist of several payments to the same creditor equalling $600 or more) within 90 days of your bankruptcy filing, this is considered to be a preference if the creditor received more than it would have if in the bankruptcy. Keep in mind that you are presumed to be insolvent within the 90 days prior to filing for bankruptcy.
If you make a payment of $600 or more to an "insider" while you are insolvent, it is considered to be a preference if made within one year prior to your filing. An insider is usually a relative or a business partner. Again, it's only a preference if the insider gets more than it would have in the bankruptcy.
If you are a business debtor (which means the majority of your debts arise from your business), the trustee will only look at payments or transfers of property that are more than $6,225.
The idea behind bankruptcy is that all creditors get equal treatment. If you favor one creditor prior to bankruptcy, so that other creditors get less in bankruptcy, this violates the goal of equal treatment. For this reason, the bankruptcy trustee has the power to "avoid" transfers. (In some situations, a creditor can bring an action to avoid a transfer.)
When a trustee avoids a transfer, he or she essentially takes back the money from the creditor. The trustee will usually start by asking the creditor to return the money. If the creditor won't comply, the trustee may have to file a lawsuit within the bankruptcy case in order to force the creditor to return the money. As the bankruptcy debtor, you must cooperate with the trustee, although you don't have to make efforts yourself to recover the money.
You may not care if the trustee tries to recoup money you paid to a regular creditor. But if the trustee is trying to get back money you paid to a relative or close friend, the situation can become uncomfortable.
Example. 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 are facing this situation, you have several options if you don't want the trustee to sue your brother for the $1,500.