Preferential Transfers Text Size:

The Bankruptcy Code seeks to promote equality and fairness among creditors by invalidating pre-bankruptcy transfers of the debtor's property that would give particular creditors more than they would receive in a chapter 7 liquidation, a "preferential transfer" or "preference" . This is done through an action to avoid the transfer or seizure under Bankruptcy Code (11 U.S.C.S. § 547). The power to avoid preferences serves to discourage creditors from engaging in a race to get at the debtor's property before bankruptcy, since they know that if they do obtain the property and perhaps hasten a bankruptcy, they will only have to surrender it to a trustee exercising the power to avoid preferences.

Section 547 Trustee Powers

With certain exceptions, the bankruptcy trustee may avoid or cancel any transfer of property of the debtor:

• To or for the benefit of a creditor
• Which was made on account of a debt owed by the debtor before the transfer was made
• Which was made while the debtor was insolvent

and the transfer was made:

• on or within 90 days before the date of filing of the bankruptcy petition or
• between 90 days and one year before the date of filing of the petition, if the creditor, at the time of such transfer was an insider

and that enables the creditor to receive more than such creditor would receive if:

• The case were a case under chapter 7 of the Code;
• The transfer had not been made, and
• Such creditor received payment of such debt to the extent provided by the provisions of the Code.

Was There a Transfer

The first issue in the analysis of a preferential transfer is whether property of the debtor has been transferred at all. In some cases the debtor may merely be transferring property held in trust for others. But if a party owing a debt to the debtor, as part of a transaction involving the debtor, pays that debt to a creditor of the debtor at the debtor's request, there has been a transfer of the debtor's property. For example, the debtor agrees to build a deck for a neighbor for a set fee, and in the 90 days before the debtor files for bankruptcy, the neighbor pays a bill owed by the debtor. The payment of the debt is a preferential transfer.

In addition, if a validly secured creditor, such as the mortgagee on a lot of land or the creditor on a car loan, repossesses property worth less than the amount of the secured debt, no preference exists since that creditor would have had a right to that property or its full value in a liquidation. But if an unsecured or partially secured creditor receives a payment on the debt within 90 days, that payment probably is a preference.

Exceptions to Preference Avoiding Power

The major exceptions to the preference section are listed in section 547(c). The creditor has the burden of establishing that it falls within one of the exceptions. Sections 547(h) and 547(i), added in 2005, also limit the trustee's preference avoiding power. The fact that the debtor might have been able to exempt the property being transferred is not a defense to an argument that the debtor made a preferential transfer that should be cancelled.

The first exception under section 547(c) is for exchanges that are "substantially contemporaneous'' exchanges for new value, e.g., cash purchases, purchases paid for immediately by check, or security interests securing new value, such as the debtor's purchase of a new piece of equipment by means of a loan and a security agreement making the equipment collateral for the loan.

Similarly, payments on debts incurred in the ordinary course of business or financial affairs of the debtor and creditor are not considered preferential transfers. To be within the "ordinary course of business," the payments must be regular day-in and day-out business dealings between the creditor and debtor or made according to ordinary business terms. Some courts have concluded that late payments may be considered within the ordinary course of business if they are consistent with the pattern of prior payments and within the range of ordinary practices of similar firms. This includes most payments for current utility services, goods bought with payment due in 30 days, and most charge accounts.

Certain security interests created within 90 days are also excluded from the preference category. These are:

• Security interests that secure new value given by the secured party to enable the debtor to acquire property and used by the debtor for that purpose, if perfected within 30 days after the debtor receives possession of the property;
• Security interests in inventory or receivables, to some extent; and
• Statutory liens (such as a tax lien) that are not avoidable.

Under section 547(c)(7), amended in 2005, a preference also may not be avoided if the transfer was a bona fide payment of a debt for a domestic support obligation, such as child support. This exemption applies whether it is a payment directly to the parent or to a child's school or other entity on the child's behalf.

Section 547(c)(8) limits the avoidance power of the trustee if the preference totals less than $600 to a single creditor and the debtor has primarily consumer debts. This provision aims to limit preference actions against loan companies and utilities, and reduces the number of preferences avoidable by debtors.

The 2005 amendments to the Bankruptcy Code created several additional limitations on the avoidance of preferences. Under section 547(c)(9), a trustee may not avoid a transfer in a case filed by a debtor who is not a consumer debtor if the transfer is less than $5,000 (as adjusted each year for inflation). Section 547(h) provides that a trustee may not avoid a transfer made as part of an alternative repayment schedule between the debtor and creditor created by an approved nonprofit budget and credit counseling agency.

Related Resources on Lawyers.com^sm

Web Resources