If you paid money to one of your creditors before you filed bankruptcy, this might have been what is called a “preferential transfer.” If the payment meets the definition of a preferential transfer that is in the bankruptcy code, the Trustee will try to recover that money from the creditor to benefit the bankruptcy estate.
A Preferential Transfer
So what is a preferential transfer? You can find the definition in section 547 of the Bankruptcy Code. That section states that a trustee may avoid any transfer of an interest of the debtor in property that was made to the benefit of the creditor, and on a debt that existed before the transfer was made. The payment must have been made while the debtor was insolvent. The payment must have been made within 90 days of the filing of the bankruptcy petition unless the creditor was an insider. In the case of an insider, the payment must have been made within a year of the bankruptcy filing. Lastly, by receiving the payment, the creditor must have received more that it would have received if it had not received the payment and it instead received a distribution under a chapter 7 bankruptcy.
Here is an example to help illustrate this point. Say Tommy’s friend loaned him $5000. Tommy gets a $2000 bonus at work, and gives that money all to his friend for payment on the loan. 10 days later, Tommy files a Chapter 7 bankruptcy. Tommy has no assets for the Trustee to distribute to creditors. This payment was made for an already existing debt, while Tommy was insolvent, within 90 days of his bankruptcy filing. Since Tommy has no assets to liquidate and distribute to creditors, Tommy’s friend would have received nothing through Tommy’s bankruptcy. In this example, the Trustee could sue Tommy’s friend to get that $2000 back.
Another example is if Sally owes her sister $30,000. Sally sells a building she owns for $20,000, and directs the closing attorney to pay that money directly to her sister in payment of the debt. 6 months later, Sally files for bankruptcy. Here the payment was made on account of an existing debt, to the benefit of Sally’s sister. As long as the Trustee can show that Sally was insolvent at the time of the transfer, and as long as Sally’s sister would have received less than $20,000 though the bankruptcy, the Trustee would have a good preference action. Since Sally’s sister would qualify as an insider, the transfer had to take place within a year of the bankruptcy filing.
There are some defenses to a preference lawsuit. In my next blog, I will review these defenses.