Preference Claims from the Debtors Point of View

How preference claims are handled is always a surprise to clients. Your daughter loans you $2000 and you pay her back with your tax refund right before you file bankruptcy. Good thing you paid her back right? Wrong. 11 USC §547 defines preferences and how they are to be treated in a bankruptcy.

What is a preference claim or preference payments? The Bankruptcy code defines a preference as:

(1) a transfer of an interest of the debtor in property;

(2) for the benefit of a creditor;

(3) for or on account of an existing debt owed by the debtor;

(4) made while the debtor was insolvent;

(5) within 90 days of the bankruptcy filing for a regular creditor or within 1 year of the bankruptcy filing to an insider;

(6) that enables the creditor to receive more than they would receive through the bankruptcy filing.

Paying your daughter back within a year before filing is a preferential payment. If you are paying back a personal loan then you have no defense to the payment and therefore the trustee can seek return of the money from your daughter to spread out to all of your creditors pro rata.

Why does the trustee do this? To avoid a debtor from “preferring” certain creditors and paying them back before filing while not paying others. The purpose of this law is to ensure that all creditors that are similarly situated receive equal treatment when a bankruptcy is filed.