Bankruptcy Questions Answered: What is a Preference Payment in Bankruptcy?

If you find yourself staring down insurmountable debt, a natural reaction could be to throw whatever money you do have toward one or more creditors in a desperate attempt to solve the problem. The sooner you make one source of debt disappear, the quicker you can get on the road to financial recovery, right? Well, as with so many things, the answer is that it depends on several factors–a major one being if you end up needing to or are already planning to file for bankruptcy.

Preference Payments Explained

After evaluating your situation, you might find that bankruptcy presents the clearest path to financial health. Once you’ve filed for bankruptcy the court will appoint a trustee to handle the repayment of creditors and potential restructuring or liquidation of your assets. As part of this process the trustee will investigate how you spent money during the time leading up to your bankruptcy. 

Especially during the 90-day period immediately prior to your filing, the trustee will be on the lookout for several things, one of which is whether you made direct payments to creditors. They could also be checking for wage garnishment or a bank levy. The lookback period stretches to 1 year for transfers or payments made to “insiders”–family members, general partners, or, in the case of chapter 11 bankruptcy, anyone else that’s in a position of control within your company.

Since you did end up filing for bankruptcy, the court views the stretch of time prior to the filing as your insolvency period. That simply means that your debts (or liabilities) at this time outweighed your assets and that bankruptcy was a likely outcome. Any payments to creditors at this time will be called into question and could be determined “preferential.” The trustee could see a payment made during this time as an unfair preference given to an individual creditor. 

These other criteria will also point to preference:

• A transfer of an interest, be it money or a security interest or guaranty
• A payment made to a third party that is for the creditor’s benefit
• Payment made strictly to settle prior debt
• Payment was made to select creditor(s) only
• A payment for unsecured debt totaled over $600
• A creditor received more than they would have through bankruptcy

Once a trustee decides that a payment was, in fact, preferential, they will bring action against the creditor in order to retrieve the payment you made. This sum will then be added to your total available assets and used to help satisfy debt among the creditors as a collective group. This obviously means that a creditor who you might have paid in full will most likely receive less than full recompense once the payment is added to the asset pool and fairly distributed. 

How To Avoid Preference Payment Issues

The obvious way to prevent the need for a preferential payment claim is not to make large payments (over $600) to creditors or “insiders” in the time leading up to filing for bankruptcy. But that could be easier said than done, especially if you weren’t anticipating a filing in your near future. If this is the case and the trustee takes legal action to try and retrieve the money, there are a few reasons, or defenses, that might enable creditors to keep the payment:

• Ordinary Course Of Business: The creditor will need to show that the payment is part of the normal course of business in the industry or per previous situations with the debtor.
• New Value: A creditor must prove that additional goods or services provided to the debtor after a payment is made correspond with the payment’s value.
• Contemporaneous Exchange: A transaction is shown to be a current exchange of payment for goods or services provided, not payment for a previous invoice.

Why Preference Payments Matter

Though there could be debts that you’d prefer to pay off and keep out of bankruptcy proceedings–like payments to friends and family or business partners–the law aims to equalize repayment across the board. That said, some creditors will be repaid first, based on the legal principle of priority payment. Certain debts, such as support obligations and recent taxes, will always be paid before others. Secured creditors will also take precedence over unsecured creditors.

The preferential payments policy aims to prevent not just the debtor from favoring any creditor, but also discourages creditors from hunting down and demanding immediate repayment from a debtor who is about to file for bankruptcy. In either situation, the trustee would likely reclaim (or “claw back”) those funds in order to disburse them on a pro rata basis.

Rely on an Experienced Ohio Bankruptcy Lawyer

When your financial situation takes a nosedive, it’s hard to know exactly which moves to make. If you need advice and answers to your nagging bankruptcy questions, get in touch with the trusted chapter 7 bankruptcy lawyers at Hausen Law, LLC. James F. Hausen has used his hard-earned skills to handle over 2,000 cases, serving the Akron and Canton areas. Contact Northeast Ohio Bankruptcy Attorneys to set up a free consultation and learn more about your bankruptcy options and employment rights.