Preference

In bankruptcy law, a preference refers to a transaction that unfairly benefits one creditor at the expense of others. The Bankruptcy Code, precisely 11 U.S.C. § 547, allows trustees to “avoid” (undo) preferential transfers made within 90 days before the bankruptcy filing occurred or within one year if the creditor is an insider, which typically refers to a family member, business partner, or any entity closely related to the debtor.
Avoiding preferences is to uphold the fundamental bankruptcy principle of equal treatment among similarly situated creditors. This principle is crucial as it prevents debtors from favoring certain creditors over others, ensuring a balanced and just distribution of assets. Without this rule, debtors might pay favored creditors just before filing, depleting assets that should be distributed fairly among all creditors.
To be considered a preference, the transfer must meet several criteria: for the benefit of a creditor and for a pre-existing debt made. At the same time, the debtor was insolvent, and it must allow the creditor to receive more than they would in a Chapter 7 liquidation. These criteria are essential to understand as they determine whether a transfer can be considered a preference. Common examples include paying off a credit card or repaying a personal loan.
If a transfer is deemed preferential, the trustee can recover the funds for the bankruptcy estate. The creditor who received the preferential transfer may have to return the funds. However, creditors have defenses, such as the ordinary course of business or contemporaneous exchange exceptions. Understanding preferences is crucial for creditors and debtors navigating bankruptcy proceedings.