Preferential Debt Payment while--or shortly before--filing bankruptcy can result in any preferential payments being voided and the money recovered by the bankruptcy trustee.
What is Preferential Debt Payment?
A preferential payment is when one creditor is treated better than others, and receives more than he, she, or it would otherwise receive in bankruptcy. There are additional criteria that might make a payment a preferential one, the two chief of which are:
- the transfer is made within 90 days prior to filing bankruptcy (or while filing); and
- the debtor is insolvent at the time of the transfer or payment (i.e. the debtor's income is not sufficient to meet the debtor's expenses and debts)
Finally a third criteria necessary for finding that a payment is a preferential transfer is that the payment was made on an already-incurred debt. Debtors are allowed to "preferentially" pay vendors, lenders, service people, etc. whom it is currently making purchases or borrowing from. If the debtor is receiving something of value at the same time as it makes the payment, the payment will not be deemed preferential.
What Happens to Preferential Payments?
The bankruptcy trustee reviews the debtor's financials, including payments made to creditors. If a payment is deemed to have been a preferential payment, the trustee can force the creditor to return it--even if the creditor was itself innocent of any wrongdoing. The money will then go back into the "pool" to be distributed among all the creditors.
Why Preferential Payment is Barred
The goal or ideal of bankruptcy is to treat all creditors--at least all those with similar types or classes of debts--the same. There will be pain for creditors, since they will only recover a fraction of what they are owed, but at least the pain should be shared equally. If preferential payments were allowed, however, the system would be opened up to the following kinds of abuses:
- A creditor intimidating, threatening, or harassing a debtor to be treated preferentially
- Collusion between creditors and debtors--such as a creditor receiving preferential treatment in exchange for "kicking back" some of the money to the debtor under the table
- A debtor using the promise of preferential treatment to manipulate debtors
To Avoid Preferential Payments
It's straightforward for a debtor to avoid making payments that may be seen as preferential. Simply don't do one or more of the following:
- Don't treat or pay one creditor better than others in the 90-day window leading up to a bankruptcy filing
- Don't pay one creditor better than another while insolvent
- Only make larger or "preferential" payments on current debts--i.e. in exchange for something of value, like goods or services
How an Attorney Can Help
A lawyer can advise you as to when bankruptcy is your best option and on when to file it. The attorney can also advise you on how to deal with creditors as you are filing (or are about to file), in order to avoid preferential payments.
