What Are Preference Payments in Bankruptcy?
When you file bankruptcy, there are rules established by the Bankruptcy Code. One rule addresses payments made to creditors within 90 days of filing for bankruptcy. The name for these payments is preference payments. As the name implies, the creditor obtaining the payment receives preference over other creditors who are also owed money. The bankruptcy court views the 90 day period prior to filing bankruptcy as a time of insolvency, and levels the playing field for creditors regarding debts paid during that 90 day period. When you file for bankruptcy, creditor payment is subject to bankruptcy rules.
The bankruptcy trustee demands that creditors receiving preference payments turn over funds they received to the bankruptcy trustee. The funds become part of the bankruptcy estate and are available for pro rata distribution to all creditors. If a creditor does not voluntarily relinquish the preference payment to the bankruptcy trustee, the trustee could sue the creditor to recover the money.
What can you do?
There are defenses to a preference action brought by the bankruptcy trustee. One defense arises in a situation described as a contemporaneous exchange for new value. Under section 547 of the Bankruptcy Code, if you paid money to a creditor in exchange for something new, then arguably the payment of money to the creditor in exchange for this new value is not a preference. A bankruptcy trustee cannot claim money exchanged contemporaneously for new value as part of the bankruptcy estate. A preference payment by definition must be for an already existing debt, not a new exchange.
Here is an example of how a preference payment could affect you, the debtor. Suppose you are doing poorly financially, but you really want to keep and pay off one credit card for future emergencies. The payment to that creditor could be considered a preference payment and you should wait 90 days before filing bankruptcy in order to protect the creditor from a preference action.
There are many factors to consider when filing bankruptcy, which is why you should seek advice from an experienced bankruptcy lawyer.