Preference Payment

Why Do Preference Laws Exist?

Preference avoidance serves two fundamental bankruptcy policies:

• Equality of distribution: Preventing a debtor from favoring certain creditors over others in the months before bankruptcy. All creditors of the same class should share equally.
• Discouraging dismemberment: Preventing aggressive creditors from pressuring a debtor into paying them at the expense of other creditors during the pre-bankruptcy period.

Importantly, preference law does not require fraud or wrongful intent. Paying a credit card bill instead of medical bills in the months before filing may be a preference payment the trustee can recover, even if the payment was innocent. That's only if all legal requirements are met and no defense protects it.

What Are the Five Elements?

The trustee must prove all five elements of § 547(b):

1. A transfer of the debtor's property to or for the benefit of a creditor — includes cash payments, property transfers, lien grants, and even involuntary transfers like garnishment
2. For or on account of an antecedent debt — the debt existed before the transfer was made (paying for groceries at the register is not a preference; paying last month's credit card bill is)
3. Made while the debtor was insolvent — debts exceeded assets at fair value. The debtor is presumed insolvent during the 90 days before filing.
4. Made within 90 days before filing (1 year for insiders) — the statutory look-back period
5. The transfer enabled the creditor to receive more than they would in a Chapter 7 liquidation. If that unsecured creditor would receive nothing in Chapter 7, a payment can meet this requirement, but the trustee can recover it only if the other requirements are met and no defense protects it.

Common Defenses to Preference Claims

Section 547(c) provides several defenses that protect creditors from clawback:

• Contemporaneous exchange (§ 547(c)(1)): The parties intended the transfer to be a simultaneous exchange of value. Example: paying cash for goods at the time of delivery.
• Ordinary course of business (§ 547(c)(2)): The payment was made in the ordinary course of business — on normal terms, according to standard industry practices. This is the most commonly litigated defense.
• Purchase money (§ 547(c)(3)): A security interest given to secure new financing that enabled the debtor to acquire the property. Example: a car loan where the lien was perfected within 30 days.
• Subsequent new value (§ 547(c)(4)): After receiving the allegedly preferential payment, the creditor provided new goods or services to the debtor. The new value offsets the preference.
• Floating lien (§ 547(c)(5)): For creditors with security interests in inventory or receivables, the preference is measured by the improvement in their position between the 90-day mark and the filing date.

Insider Preferences: The 1-Year Look-Back

Payments to insiders receive heightened scrutiny with a 1-year look-back. Insiders include:

• Family members: spouse, parent, child, sibling
• Business partners and partnership affiliates
• Corporate officers, directors, and persons in control
• General partners of limited partnerships

The most common insider preference scenario: a debtor who repays a family loan within a year before filing. Even a legitimate creditor can lose the payment. The trustee may recover it if it gave the family member more than they'd receive in Chapter 7 without it, all other legal requirements are met, and no defense protects it.

Preference Payments and Household Distress

Preference law intersects with financial distress in practical ways. Families under pressure often pay back relatives first (out of obligation or family pressure), make large payments on one credit card while ignoring others, or rush to pay off car loans to protect the vehicle. These well-intentioned payments can be clawed back by the trustee. Bankruptcy attorneys advise clients to avoid selective payments in the months before filing.