Understanding Preferential Transfers in Bankruptcy

Cash GiftIf your company is considering filing bankruptcy and you deal with several vendors, it is important to understand what is meant by the term “preferential transfer.” A preferential transfer is a payment (in money, goods or other) that is made to a creditor within the 90 days preceding the filing of the bankruptcy petition that results in that creditor receiving more than it otherwise should have. The result is that the creditor was “preferred” over other similarly-situated creditors.

What happens if a preference occurs?

If a preferential payment is made, the trustee has the ability to recover the money or goods in order to administer them as part of your bankruptcy estate for the benefit of all the creditors. This can be accomplished by the trustee asking the creditor to return the payment or, if necessary, a lawsuit called a “preference action” can be filed within the bankruptcy case.

What about payments to secured creditors?

A question can arise for secured creditors because foreclosing on collateral pledged to secure a loan does not provide the creditor more than it would have received if the collateral had been liquidated in the bankruptcy case. Naturally, there are some exceptions to this rule. If a secured creditor’s claim is greater than the value of the collateral, the amount of the secured claim is typically limited to the value of the collateral as of the petition date. Any remaining deficiency balance becomes an unsecured claim. Thus, some bankruptcy judges have ruled that any payment made to a secured creditor within the 90-day period is assumed to have been made for the unsecured part of the lender’s claim and therefore potentially subject to a preference action.

Secured creditor defenses

If you are a secured creditor and you are facing a preference action, it is important to understand you may have valid defenses to the preference action. The primary defense used by secured creditors is the “ordinary course of business” defense, which means the payment was made during the ordinary course of business between the debtor and creditor so it is not extra-ordinary or preferential.

To learn more about preferential transfers, contact us for a free consultation.

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