Love Thy Creditors Equally: Preferential Transfers in Bankruptcy

If you are considering filing for bankruptcy, you may be faced with a sea of creditors aggressively seeking repayment on your debts. Because of this, you may be tempted to use your remaining assets to pay one creditor over another before you file for bankruptcy. However, repaying one creditor over another can quickly turn into a useless (if not harmful) gesture once you file for bankruptcy.

Preferential Transfers

Under bankruptcy law, repaying one creditor and not another could be considered a "preferential transfer." These types of transfers are prohibited by bankruptcy law in order to give all creditors an equal chance to get repaid. The law exists to prevent debtors from favoring one creditor over another before they file for bankruptcy.

For a transaction to be considered a preferential transfer, all of the following must occur:

  • There must be a transfer of the debtor's assets.
  • The transfer must be made to pay off a debt the debtor owes.
  • The transfer must be made within 90 days before the bankruptcy petition is filed or within one year if the creditor is an "insider." Insiders can be considered family members, business associates, or companies the debtor owns or is affiliated with.
  • The transfer must be made while the debtor is insolvent, or incapable of paying all of his or her debts in full.
  • The transfer must give the creditor a greater return (i.e. more money or a better position) on the debt owed than he or she would receive under the bankruptcy laws.

If a debtor makes a preferential transfer to a creditor, the bankruptcy trustee has the power to void the transaction. This means that the trustee can force the creditor to return the payment that was made. The payment will then become part of the bankruptcy estate and be divided proportionately among all the creditors according to the bankruptcy laws.

Although they may as appear to be preferential transfers on the surface, there are some transactions of this nature that are legitimate in the eyes of the law. For example, the bankruptcy code does not consider transfers for domestic support obligations, such as alimony or child support, as preferential. In addition, certain business transactions do not qualify as preferences.

If you are considering bankruptcy, you may be concerned about how your creditors-especially your family and business associates-will be treated once you file. If you have questions about preferential transfers, contact an experienced bankruptcy attorney. He or she will be able to guide you through the bankruptcy process and ensure that your financial interests are met.