Preferential Debt Payments in Bankruptcy

A preferential debt payment is a payment made for the benefit of certain creditors shortly before filing for bankruptcy.

Most debtors have certain obligations they would rather pay back before others (such as loans from family and friends). But if you pay back a preferred creditor prior to filing for bankruptcy, it can be considered a preferential debt payment. The bankruptcy trustee has the power to avoid (undo) preferential payments and recover that money or property to distribute among all of your creditors. Read on to learn more about preferential debt payments in bankruptcy.

What Is a Preferential Debt Payment?

A preferential debt payment is essentially a payment or transfer of property made for the benefit of certain creditors shortly before filing for bankruptcy. For example, if you pay back a loan from your mother prior to filing your case, it will usually be considered a preferential debt payment. Below, we discuss when a debt payment will be deemed preferential in bankruptcy.

Payments Within 90 Days of Bankruptcy

If you make payments of over $600 in aggregate to a creditor in the 90-day period prior to your filing date while you are insolvent (meaning your debts exceed your assets) and that payment allows the creditor to receive more than it would otherwise have through your bankruptcy, it is a preferential debt payment. Also, keep in mind that bankruptcy law presumes you are insolvent during the 90-day period prior to bankruptcy. As a result, the trustee does not have to prove insolvency in most cases.

Payments to Insiders Within One Year of Bankruptcy

Any payments you make to insiders (such as your family, friends, or business partners) are also subject to the above rules. But the look back period is even greater. Payments to insiders are deemed preferential if made within one year of bankruptcy instead of just 90 days.

The Trustee Can Avoid Preferential Payments and Get the Money Back

If the court determines that you made a preferential debt payment prior to filing your case, the trustee can avoid that payment and get the money back for the benefit of all your creditors. This is commonly referred to as a clawback. Keep in mind that preferential payments are not illegal unless you made them with the intent to defraud your creditors or hide money from the trustee. But the recipient of the payment will still have to return the money.

Why Can the Trustee Claw Back Preferential Payments?

One of the goals of bankruptcy is fair treatment of all creditors. If you pay back a preferred creditor before filing your case, other creditors may not be receiving as much as they would be entitled to in your bankruptcy. As a result, the clawback provision of the Bankruptcy Code allows the trustee to recover preferential payments and distribute the money among all of your creditors.

How Can You Avoid Making a Preferential Payment?

If you have recently made a debt payment, the simplest way to avoid having a preferential payment issue come up is to delay filing your bankruptcy. If you are outside the preference period, there is less chance that the trustee will argue you made a preferential debt payment. However, if you intentionally try to hide assets or defraud your creditors, you risk losing the benefit of your discharge and being prosecuted criminally.

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