Adversary Proceedings in Bankruptcy: Preferential Transfers

If you paid money to a creditor before you filed bankruptcy, the bankruptcy trustee may be able to get this money back.

If you paid money to a creditor before you filed bankruptcy, the bankruptcy trustee may be able to get this money back for the bankruptcy estate. The trustee can do this if the transaction meets the legal definition of a "preferential transfer."

The trustee is interested in recovering property for the bankruptcy estate because the trustee is charged with making sure your unsecured creditors get repaid as much as possible, whether you file Chapter 7 or Chapter 13 bankruptcy. Bankruptcy law grants the trustee many powers to carry out that duty, and the trustee looks not only at your assets and finances at the time of your bankruptcy but also at what you did before you filed. (Learn more about the role of the bankruptcy trustee in your case.)

What is a Preferential Transfer?

A payment or transfer of property is a preferential transfer, also called a preference or a preference payment, if:

  • you pay more than $600 to one creditor (or $6,225 if most of your debts are business debts)
  • the payment is on account of antecedent debt (that is, debt you already owed)
  • the payment allowed the creditor to receive more than what it would have received in a Chapter 7 (most creditors receive nothing in Chapter 7)
  • you were insolvent when you made the payment (this means your debts exceeded your assets), and
  • you made the payment within 90 days before you filed bankruptcy (or, if the recipient was a family member, one year)

Note: The court will presume that you were insolvent within the 90 days prior to filing bankruptcy.

Example 1. Tom owed $15,000 on a personal loan from his bank. He receives a tax refund of $5,000; in a last ditch effort to get debt relief, he pays the $5,000 to the bank for the loan. Forty days later, he files Chapter 7. The trustee will sue the bank to recover the $5,000, because Tom is presumed to have been insolvent; the payment was made within 90 days before he filed his bankruptcy; the payment was on an antecedent debt; if Tom had not paid the bank and had filed Chapter 7, the bank would have received less than $5,000; and the payment was over $600.

Example 2. Jennifer's mother loaned her $10,000 in 2009. In 2011, Jennifer received a bonus at work and repaid her mother in full. Less than a year later, in 2012, Jennifer is unemployed and files Chapter 7. Jennifer's trustee can sue Jennifer's mother for the $10,000 payment if the trustee can prove that Jennifer was insolvent at the time of the transfer and that Jennifer's mother would have received less than $10,000 in Jennifer's bankruptcy case if Jennifer had not made that payment.

Defenses to a Preference Lawsuit

If a bankruptcy trustee sues a creditor to recover a preferential transfer, the creditor may have a defense to the action. Common defenses include:

Contemporaneous Exchange for New Value

If you repay a creditor and the creditor in return grants you more credit or gives you something else of value, and that exchange was contemporaneous (within a short time period), the creditor may have a defense.

Example. Janet's credit card has a balance of $3,000. She pays off the debt; two weeks later, she uses her credit card to get her daughter braces. The new charge is $3,500; this is a contemporaneous exchange for new value.

Payment Made in Ordinary Course of Business

If the debt was incurred and the payment made in the ordinary course of your business with the creditor, the creditor may have a defense.

Example. Larry is a sole proprietor. One of his vendors is X Corp. Larry buys inventory from X Corp. on a monthly basis and pays his invoices every 45 days. He receives inventory on May 1 with a bill for $50,000. He pays the invoice in full on June 16 and files bankruptcy 60 days later. The debt (the $50,000) was incurred in the ordinary course of business between Larry and X Corp., and Larry paid the debt within the ordinary course of business between Larry and X Corp. Therefore, X Corp. likely has a defense against a preference action by Larry's trustee.

Security Interest

If you own a business and give a creditor a lien on your inventory or receivables instead of paying money (granting a lien is considered a transfer), the creditor might have a defense, depending on when you granted the lien, the amount of the debt and the value of the receivables.

Unavoidable Statutory Lien

If the creditor obtains a lien against your property because a law grants such a lien (again, granting a lien is considered a transfer), the creditor may have a defense depending on the circumstances of the lien.

Domestic Support Obligation

If the debt you repaid is for child support, spousal support or any other domestic support obligation, the trustee cannot avoid the transfer.

Example. Todd owes $10,000 in back child support to his ex-wife. He repays her $10,000 and files bankruptcy three days later. The trustee cannot avoid the transfer as long as Todd made the payment for purposes of catching up on his child support and not for purposes of hiding his money from the trustee.

Transfers Are Less Than $600 (or $6,225 if Majority of Debts Are Business Debts)

The trustee cannot sue for transfers that aggregate less than $600 (or $6,225 if more than 50% of your debts are business debts).

Example. Lisa owned a small business and personally guaranteed much of her small business loans. The business folded, and Lisa filed bankruptcy. Her own personal debt was limited to a credit card bill of $5,000 and her mortgage, which was $200,000. The business debt she personally guaranteed totaled $600,000. Before filing bankruptcy, in an attempt to catch up, she repaid one of her small business loans in four installments of $1,000 each. Because Lisa’s debts are primarily business debts and the transfers totaled $4,000 (less than $6,225), the bank has a defense to a preferential transfer lawsuit.

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