Typically, prior to filing for bankruptcy, most debtors have already been struggling with debt for a year or more. During that time, while juggling which bills and creditors to pay, they may have made preferential payments to some creditors over others. A common form of a preferential payment is a loan repayment to a family member who a debtor may not even consider to be a creditor. Section 547 of the Bankruptcy Code makes certain preferential payments voidable by the Bankruptcy Trustee. If such a preference is discovered, the creditor may be required to return the money to the Trustee and Bankruptcy Estate of the debtor. If the creditor doesn’t cooperate or return the money, the Trustee can bring an action in the Bankruptcy Court to recover the funds paid by the debtor. The funds would then be distributed to creditors who filed claims in the case.

What is a Preference?

The policy behind the bankruptcy law regarding preferences is clear, a debtor should not be permitted to “prefer” one creditor over another shortly before filing for bankruptcy. Any large payments made shortly before filing for bankruptcy should be brought into the bankruptcy estate for a more equitable distribution among all the creditors of the debtor. The bankruptcy preference policy has two primary purposes:

• to promote the equality of distribution to creditors
• to reduce a creditors’ incentive for any last-minute rushes to collect from debtor by providing for the recapture of any large payments prior to the filing of a bankruptcy case.

Preferences in bankruptcy law are designed to put all creditors on a relatively level playing field with respect to a debtor’s non-exempt assets available prior to a bankruptcy filing.

Preference Timeframes

The Bankruptcy Code allows for the recovery of preferential payments from all creditors that were made within 90 days of the filing. This period is extended to 1 year if the creditor was an “insider”. This category includes the following:

• Family Members
• Business Partners
• Companies controlled by the debtor

For example, if a debtor pays back their brother $19,000.00 five months prior to filing, pays back their business partner $20,000.00 nine months prior to filing, and pays back a loan from their business of $26,000.00 three months prior to filing, all of these payments would be potentially recoverable by a Bankruptcy Trustee in the debtor’s bankruptcy, providing a pro-rata benefit for all of the other creditors in the case. However, if this same debtor made a large payment of $35,000.00 to American Express eight months prior to filing, this preferential payment would not be recoverable, since American Express is not an insider, and the payment was made more than 90 days before filing.

Preference Vs. Transfer

Sometimes a debtor confuses a transaction that may be a preference with what may be considered a transfer. If the debtor transfers either money or property prior to the filing of their bankruptcy petition, they create a potential asset in their bankruptcy case. Unless the debtor was solvent at the time, the transfer may be considered fraudulent and clawed back by the Bankruptcy Trustee for a distribution to creditors. A preference is a type of transfer, as mentioned above, that has specific time frames close to the filing date and they only involve the repayment of a debt. Debtors often do not realize that paying back friends or family will be an issue in their case because a family member is not a traditional creditor like a credit card or personal loan. Transfers on the other hand have a much longer lookback period and do not need to involve a debt of any sort. If a debtor received either no or inadequate consideration for a transfer, it may be deemed to be fraudulent, and therefore voidable.

Trustees can void transfers made by the debtor either under state law or the Bankruptcy Code. For many years, In New York, the fraudulent transfer statute had a 6-year lookback period. This law has now been updated and the lookback period is now 4-years for transfers made after on or after April 4, 2020. The older 6-year lookback period will still apply for a couple of years in Bankruptcy Court for transfers made before April 4, 2020. If a debtor was repaying a loan, it is best to have some proof that they were repaying a loan versus simply making a transfer of money.

A Debtor Must Disclose Preferential Payments to Insiders in their Statement of Financial Affairs (SOFA)

There are two questions on the SOFA that require debtors to disclose preferential payments made prior to their bankruptcy filing:

SOFA Question #6:

For case with primarily non-consumer debts

During the 90 days before you filed for bankruptcy, did you pay any creditor a total of $7,575* or more?

For case with primarily consumer debts

During the 90 days before you filed for bankruptcy, did you pay any creditor a total of $600 or more?

SOFA Question #7:

Within 1 year before you filed for bankruptcy, did you make a payment on a debt you owed anyone who was an insider?

SOFA Question #8:

Within 1 year before you filed for bankruptcy, did you make any payments or transfer any property on account of a debt that benefited an insider?

These questions are used to identify any preferential payments made by a debtor. Additionally, the debtor must also disclose any preferential payments to any other creditors if questioned about them at their 341(a) Meeting before the Bankruptcy Trustee. Different Trustees tend to ask about different preferential amounts, some will ask about payments in excess of$1000.00 or more, while others may ask about $5000.00 or more.

What are the Consequences of a Preference in a Bankruptcy Case?

If a Trustee identifies a preferential payment made by a debtor, they may seek the return of the funds or property transferred. If the payment isn’t voluntarily returned or a settlement for the amount obtained, the Trustee can commence an adversary proceeding to recover the money at issue. However, they will only seek the return of such preferences if it is likely to result in a meaningful benefit to the bankruptcy estate. For example, if a Trustee identifies one $1,000.00 preference, they may not seek the return of the funds and abandon the assets. Conversely, if they uncover a $50,000.00 preference, they will most likely attempt to pursue it.

Contact the Law Offices of David I Pankin, PC

If you have any questions about preferences or transfers when filing for bankruptcy, please feel free to contact the Law Offices of David I. Pankin, P.C. at 888-529-9600 or by using our easy online contact form. We have almost 30 years of experience in both Chapter 7 and Chapter 13 bankruptcy. Contact our office today to schedule a free consultation.