Creditors Beware: Preferences and You

The old saying goes, "Patience is a virtue." However, it is often hard for creditors seeking payment from a financially distressed debtor to put these words into action, but they may benefit from doing so. Why? Because becoming overzealous and accepting or demanding a payment from a financially distressed debtor to the creditor may be an avoidable preference if the debtor files for bankruptcy soon after. This blog post will detail what a preference is, the consequences of enjoying a preference, and exceptions created by the Bankruptcy Code. 

A preference is defined by the United States Bankruptcy Code in 11 U.S.C. 547 (b). Essentially an avoidable preference includes any transfer/payment an insolvent debtor makes to a creditor for a past debt 90 days before (or a year if the creditor is an insider) they file for bankruptcy. The payment/transfer must also put the creditor in a better position than they would have been the transfer not been made in order to be considered a preference. On this last requirement, it is important to note that payments to fully secured creditors cannot be preferences.

The consequence of accepting a preference is that it becomes avoidable. What does this mean? Simply, the trustee in bankruptcy may file a preference action under 11 U.S.C. 550 and have you, the creditor, give the payment back to the estate. In the case of a security interest being given to the creditor, the security interest could be stripped by the trustee in bankruptcy. If property was exchanged to the creditor, the property or its value would have to be returned to the estate.

There are three common defenses creditors use when faced with a preference action. First, if the payment/transfer is made in the "ordinary course of business" the exchange is not a preference. Second, if there was a "contemporaneous exchange of new goods or service", the payment/transfer to a creditor is not a preference. Third, the preference may be offset by subsequent new value given to the debtor after the preference was made.

Here, at Taylor Dunham and Rodriguez LLP we have experience litigating on behalf of creditors and aggressively pursuing their rights. If you are a creditor in need of legal assistance, do not hesitate to contact Taylor Dunham and Rodriguez LLP today.

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