Preferential Payments in Bankruptcy: Understanding and Defending Against Them

What are Preferential Payments?

Preferential payments are payments made by a debtor to a creditor within a specific time period leading up to the bankruptcy filing. These payments are seen as preferential because they benefit certain creditors at the expense of others, potentially distorting the equitable distribution of assets among creditors. The preference period typically extends back 90 days from the bankruptcy filing date for ordinary creditors, and 1 year for "insiders" such as family members or business associates.

Reasons for Scrutinizing Preferential Payments:

The bankruptcy code aims to promote fairness among creditors and prevent debtors from favoring specific creditors before filing for bankruptcy. Scrutinizing preferential payments serves several purposes:

1. Ensuring Equitable Distribution: Preferential payments can upset the equal treatment of creditors by giving certain creditors an advantage over others. By examining and potentially recovering these payments, the bankruptcy trustee can redistribute them among all creditors more fairly.

2. Discouraging Fraudulent Transfers: In some cases, preferential payments may be used as a means to hide assets or divert funds away from the bankruptcy estate. Scrutiny of preferential payments helps uncover potential fraudulent activity and ensures that all assets are included in the bankruptcy estate.

3. Preserving the Bankruptcy Estate: Preferential payments can deplete the debtor's assets and reduce the overall pool available to satisfy creditors. By recovering these payments, the bankruptcy estate is preserved and better able to address the claims of all creditors.

Defenses to Preferential Payments:

While preferential payments are subject to scrutiny, certain defenses can be employed to protect these payments. Some common defenses include:

1. Ordinary Course of Business: If the payment was made in the ordinary course of business or according to ordinary business terms, it may be exempt from being deemed preferential. Payments made in the normal course of business are typically not considered preferential, as they reflect routine transactions.

2. Subsequent New Value: If the creditor provided new goods or services to the debtor after the preferential payment, that new value can serve as a defense. In such cases, the creditor may be entitled to retain the preferential payment to the extent of the new value provided.

3. Contemporaneous Exchange: If the payment was made in exchange for new goods or services received by the debtor at the same time, it may be considered a contemporaneous exchange. These payments are generally not considered preferential since they represent a fair exchange of value.

4. Lack of Preference: The debtor or creditor may argue that the payment in question does not meet the criteria for preferential treatment. This defense requires demonstrating that the payment falls outside the specified time period or other requirements outlined in the bankruptcy code.

Consulting with an Attorney:

Navigating the complexities of preferential payments and defending against them requires a thorough understanding of bankruptcy laws and regulations. It is advisable to consult with an experienced bankruptcy attorney who can assess your specific circumstances, identify potential defenses, and guide you through the legal process.

Conclusion:

Preferential payments in bankruptcy cases are subject to scrutiny to ensure equitable distribution among creditors and protect the bankruptcy estate. Understanding the concept of preferential payments, the reasons for their scrutiny, and the available defenses is essential for both debtors and creditors involved in bankruptcy proceedings