Bankruptcy Preference Law

Written by daniel gruttadaro
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Bankruptcy Preference Law
Suppliers of struggling companies must be aware of the dangers posed by preference law. (warehouse image by Niki from Fotolia.com)

A preference can occur when a payment is made to a creditor within 90 days of a debtor filing for bankruptcy and this payment places a creditor in a better position than he would have been in if he had instead been left with a bankruptcy claim, as with similarly positioned creditors. Secured creditors, such as a bank holding a mortgage, will generally be unaffected by preference law because they would be in the same position regardless of whether they had been left with a claim because their interests are secured.

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The Bankruptcy Trustee

One of the parties that can address the issue of preferences is the bankruptcy trustee. The bankruptcy trustee is a court-appointed person who oversees a bankruptcy case. His role will differ based on the chapter the bankruptcy case is filed under and whether the filing entity is a natural person or a business.

Preference vs. Fraudulent Conveyance

Both preferences and fraudulent conveyances are transfers of wealth that can be reversed by the bankruptcy trustee. However, unlike a preference, a fraudulent conveyance does not require that there be an underlying debt. Despite its name, a "fraudulent conveyance" does not require that there be actual intent to defraud.

Adversary Proceeding

Adversary proceedings are a type of litigation that occurs within a bankruptcy case. In a preference bankruptcy proceeding, in effect, the other creditors are suing a creditor which received more than the rest.

Defenses

Some ways in which a preference adversary proceeding can be defended against by a creditor include the ordinary course of business defence and the subsequent new value defence. An ordinary course of business defence will succeed if the way in which the debtor paid the creditor for the previous year was consistent with how it paid the creditor during the last 90 days. The subsequent new value defence will succeed if the creditor continued to provide services to the debtor after the payment made within the previous 90 days.

Significance

There is no requirement that there be intent for a preference to have occurred. The purpose of the preference is to prevent one creditor from unfairly receiving more than the others; whether that creditor knew the bankruptcy was coming or the debtor wanted him to receive more than the other creditors is irrelevant.

Impacts

Firms that do business with a debtor that is nearly insolvent are sometimes surprised when hit with an adversary proceeding. They sell goods on credit, are paid for them and then are, in effect, sued by other creditors.

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