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The Bankruptcy Code permits a trustee, or a debtor-in-possession, to recover from creditors payments made shortly before the bankruptcy filing where the payment gave the creditor more than other, similarly situated, creditors would get through the bankruptcy process.
The policy behind the statute is to diminish the advantages that a creditor might get by litigation or by aggressive collection actions that force the debtor into bankruptcy. That is accomplished by making payments received in the 90 days before filing recoverable in bankruptcy.
It is neither wrong of the debtor to make a preferential payment nor wrong of a creditor to accept it. The preference statutes are simply an attempt to achieve an equity between creditors within a bankruptcy.
Creditors are almost always better off attempting to get payment of their claims from the debtors and dealing with any efforts to recover the money when, and if, such attempts are made in bankruptcy.
Is It A Preference?
Bankruptcy Code Section 547 defines a preference as:
- Payment on an antecedent (as opposed to current) debt
- Payment made while the debtor was insolvent
- Payment to a noninsider creditor within 90 days of the filing of the bankruptcy
- Payment that allows the creditor to receive more on its claim than it would have, had the payment not been made and the claim paid through the bankruptcy proceeding
Note that payments to a fully secured creditor aren’t preferences because the creditor did not receive more than he or she would have in bankruptcy, where the creditor would get the value of the collateral.
A nonobvious preference may occur when the creditor converts an unsecured debt to a secured debt by recording a financing statement long after the transaction with which it was associated, by obtaining a writ of attachment or by recording a judgment lien.
Creditors are best served by the prompt perfection of such liens to lessen the possibility that the advantage obtained by getting the lien is lost in a preference recovery action in a subsequent bankruptcy.
Defense To Preference Actions
Defenses to the recovery of a preference are found in 11 U.S.C 547(c). They are:
- Contemporaneous exchanges
- Payments made in the ordinary course of business of the debtor and the creditor on ordinary business terms
- Security interests that secure debts that bring new value to the debtor
- Amounts of subsequent credit extended and unpaid
The above referred to defenses need to be raised in an answer to a preference complaint. The burden of proof lies with the creditor to establish that despite the elements of a preference, the transfer is protected by one or more of these defenses.
The Bankruptcy Code also permits the recovery of payments on old claims owed to insiders, such as relatives, corporate officers or directors, or related entities. For insiders, the trustee can look back to payments made within a year of the bankruptcy filing. This provision attempts to prevent the debtor from paying relatives and business decision-makers at the expense of the trade creditors.
In an insider preference action, there is no presumption that the debtor was insolvent when the payment was made and thus the proof of these kinds of actions is sometimes more complex for the trustee.
We encourage you to call 515-421-9068 or use our online contact form to schedule a free one-hour consultation with a lawyer who emphasizes on clear communication and cost-efficient solutions. We will review your situation and recommend an effective course of action.