The Bankruptcy Code in § 547 prohibits bankruptcy debtors from making preferential payments to those that they owe money. This section of the bankruptcy code promotes the fair and equal treatment of creditors. However, on occasion, bankruptcy debtors, whether from indifference or ignorance, will make these preferential payments, thus triggering certain events in the bankruptcy case.
The prohibition against preferences serves the purpose of removing the incentive for creditors to force debtors into bankruptcy. Why? Because of the possibility that any money they receive soon before the bankruptcy filing may have to be relinquished to the bankruptcy trustee. The law of preferences also discourages financially troubled debtors from favoring creditors to the detriment of those creditors remaining in the bankruptcy case.
A preference occurs when
- a bankruptcy debtor
- who is insolvent
- makes a payment
- within 90 days of filing bankruptcy
- for a previously incurred debt
- to a creditor who is not defined as an insider,
- that allows the creditor to receive more than it would have from the bankruptcy case.
A debtor is not penalized by having to pay an amount equal to the preference to the trustee. Rather, the bankruptcy trustee recovers the preference from the creditor. Pursuant to § 550 of the Bankruptcy Code, a trustee may avoid and recover any preferential payments by instituting a lawsuit against the creditor.
When the debtor makes a preferential payment, the trustee typically asserts a preference claim with a demand letter. The assertion of a preference claim must proceed by the filing of an adversary proceeding complaint rather than motion, which allows the defendant additional procedural safeguards and the opportunity for formal discovery. Many preference claims are settled without the necessity of formal litigation.
11 U.S.C. 547(c) outlines a debtor’s available defenses to a trustee recovering a preference. These include
*Substantially contemporaneous exchange
If the payment or other transfer the creditor received from the debtor was intended by both parties to occur at the same time as the sale or transfer of something of new value to the debtor, the preferential payment would be exempted from turnover in its entirety.
*Payments made in the ordinary course of business
This defense is the most common of the preference defenses. BAPCPA modified this defense to make it easier for creditors to establish “ordinariness” when showing a transfer was in the “ordinary course of business.”
*Purchase money security interests
This defense requires
- a specific security agreement describing the property;
- funds used exclusively to purchase the property;
- the debtor does purchase the property; and
- the creditor perfects its security interest within 30 days of the debtor receiving the item.
This defense provides that a transfer may not be avoided to the extent that after the transfer, the creditor gave new value to the debtor on an unsecured basis. This allows the new credit to act as a defense to a subsequent preference lawsuit.
*Floating liens or improvement in lien position
A holder of a perfected security interest in inventory or accounts receivable will not be avoided as a preference unless the creditor improves its position during the preference period.
*De minimis payments
The Bankruptcy Code excludes from preference liability transfers that are deemed excessively minimal. For debtors whose debts are primarily consumer debts, the de minimis limit is $600.00.
Determining if a prepetition payment to a creditor is a preference may be a difficult analysis and requires the assistance of an experienced bankruptcy attorney. Why should you consider the Morrison Law Group? We are passionate about helping people. The team of attorneys and staff at the Morrison Law Group cares about its clients. We strive for complete client satisfaction. Call 801.456.9933 today to schedule a FREE consultation. We have locations in Ogden, Logan, Sandy, and St. George to serve the residents of the counties of Weber, Cache, Salt Lake, Utah, Morgan, Davis, Washington, and surrounding areas.