Why a Preference Payment is a Bad Thing

October 24, 2009

When we were children a preference was a good thing, such as: I prefer Johnny on my team for kickball; or my preference is chocolate ice cream. In the bankruptcy world a preference payment is a bad thing. A preference payment is a transfer of money by a debtor, on account of a pre-existing debt, that is made while the debtor is insolvent, and gives the creditor more than it would receive from the liquidation of the debtor’s assets during a chapter 7.

The idea behind a preference payment is that the debtor chose to pay a certain creditor instead of other creditors – the debtor “preferred” this creditor. Preference payments are unfair to the debtor’s other creditors, and, if the transaction took place within 90 days, the bankruptcy trustee can compel the turnover of this preference payment to the bankruptcy estate for equal distribution to all creditors. And there is one other important caveat to preference payments: if the payment is made to an “insider,” then the avoidance period is one year. An “insider” is a generally a relative, business partner, etc. who has a special relationship with the debtor.

A common preference payment scenario is a payment by the debtor to a family member on account of a previous debt. For example: Mary borrows $3,000 from her mother to help pay bills. In March Mary receives her income tax refund and repays her mother the $3,000. Mary files bankruptcy in May, and doesn’t tell her bankruptcy attorney about the March payment. The trustee learns of the payment while examining the debtor’s bank statements and sues Mary’s mother to recover the $3,000 for the bankruptcy estate.

This awful situation for Mary and her mother can be easily avoided. First, do not withhold information from your attorney. Second, provide your attorney with any requested documents. Third, do not pay any creditor (or relative) without first consulting with your attorney. Cooperating with your attorney can ensure that your bankruptcy case is preference-free.

 

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