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Newburgh Area Bankruptcy Lawyers Explain Preferential Transfers in New York

Bankruptcy Code § 547 authorizes a Trustee to recapture, for the benefit of all creditors, asset transfers and/ or debt repayments made within certain time frames to a creditor whom the debtor has favored, or preferred. The U.S. Supreme Court has defined a preferential transfer as “a transfer that enables a creditor to receive payment of a greater percentage of his claim against the debtor than he would have received if the transfer had not been made and he had participated in the distribution of the assets of the bankruptcy estate.” Union Bank v. Wolas, 502 US 151, 160–61. The stated policy behind this statute is to discourage a “race to the courthouse” by aggressive creditors during the debtor’s descent into bankruptcy, thereby insuring that all creditors (including the non-aggressive ones) receive an equal share of the debtor’s rapidly depleting assets.

A preferential transfer is defined as any payment of money or transfer of property made by a debtor where:

  1. The transfer was made to or for the benefit of a creditor;
  2. The transfer was made for or on account of a debt that was owed before the transfer was made;
  3. The transfer was made while the debtor was insolvent. It should be noted that the statute creates a presumption that the debtor was insolvent during the ninety (90) day period prior to the bankruptcy filing, although this presumption is rebuttable;
  4. The transfer was made within ninety (90) days of the bankruptcy filing, or within one year of the filing if the recipient is an insider, such as a family member or close business associate; and
  5. The transfer enabled the creditor to receive more than such creditor would receive in a Chapter 7 bankruptcy liquidation if the transfer had not been made.

The Trustee must prove all five (5) of the above elements before a preferential transfer can be avoided and the property then recovered.

Example # 1: The debtor has $10,000.00 in non-exempt assets for the Trustee to liquidate and $50,000.00 in unsecured debt, including a $5,000.00 debt to a friend that he repays one week prior to the bankruptcy filing. The repayment to the friend is a preference because it was made within 90 days of the filing to repay an old debt, and resulted in the friend having his debt paid in full, rather than him receiving just a 20% distribution through the bankruptcy, like all of the other creditors.

Example # 2: Same fact pattern as above, except instead of repaying the friend $5,000.00 the debtor only repays him $1,000.00 during the week prior to filing. This is probably not a preference, as only 20% of the debt was repaid prior to the filing, which is the same percentage he and all other creditors would have received through the bankruptcy.

There are several defenses available to a creditor being sued by the Trustee to recover a preferential transfer, and the burden of proof to establish these defenses falls upon said creditor. The law concerning preferences and the defense of preference lawsuits is some of the most complicated and convoluted in all of bankruptcy. The following list of available defenses to preference claims is not a complete list, but references those most relevant to the typical consumer in bankruptcy:

  1. There was a contemporaneous exchange for new value between the debtor and creditor. Example: The debtor is a salesman who owes his supplier $5,000.00. If the debtor repays $5,000.00 to his supplier and at or about the same time receives a new shipment of inventory of comparable value from the supplier, the payment is not a preference.
  2. The debt was incurred in the ordinary course of debtor’s business with the creditor, and the repayment was made in the ordinary course of debtor’s business with the creditor, or it was made according to ordinary business terms in the business market where the debtor operates. Example: The debtor has a history of repaying his long time supplier within 45 days of receiving a shipment. Any repayment made in accordance with these terms is not a preference.
  3. Subsequent to the payment, the creditor extended new value or made a subsequent advance. The preference can be offset to the extent of the subsequent advance. Example: A debtor paid $5,000.00 on a credit card account and thereafter took a $4,000.00 cash advance from the same creditor. Due to the statutory offset, the Trustee can only recover $1,000.00 as a preference.
  4. The transfer was a bona fide payment of alimony, maintenance or support made pursuant to a matrimonial agreement, court order or decree.
  5. If the debtor has primarily consumer debts, the aggregate value of the transfer to the creditor is less than $600.00. If the debtor’s debts are primarily non-consumer (i.e. business) debts, the aggregate value of the transfer to the creditor is less than $5,475.00.
  6. Although not a statutory defense, the courts have constructed an “earmarking defense” which provides that where a third party (including a guarantor on a debt) makes a payment for the debtor or provides funds to the debtor “earmarked” for payment on a particular debt, it is not a preference. Example: Grandma repays $5,000.00 toward one of debtor’s credit cards one week before the debtor files for bankruptcy. Grandma’s payment is not a preference.

It should be noted that payments to fully secured creditors (i.e. a creditor who has a lien on something, such as a mortgage) are not generally preferences because the creditor does not receive more than would have been received in a bankruptcy distribution. If the collateral were to be liquidated in bankruptcy, the secured creditor would have to be paid in full.

Notwithstanding the above, outside of the bankruptcy world there is usually nothing wrong with a debtor repaying a preferred creditor, even to the exclusion of all other creditors. Likewise, in the real world there is nothing wrong with the preferred creditor accepting such a payment. A problem is created only if the debtor files bankruptcy within 90 days (or one year for insiders) of such a payment, as it is only in bankruptcy that the preference statute exists.