Preferential transfers, in plain language, are payments to certain creditors that allow those creditors to receive a greater benefit that creditors who were not paid.   For example, if a person owes money to several creditors, such as credit cards, medical bills, and personal loans, and makes a payment only to the hospital to pay off medical bills, the hospital has received “preferential” treatment.  If the transfer is significant, and made a short time before the filing of a Bankruptcy case, the Chapter 7 Trustee may try to “avoid,” or recover, the transfer to distribute it equally to other creditors.   Unlike fraudulent transfers, preferential transfers is a legal concept that exists only in Bankruptcy law.  In addition, there is no requirement that the preferential payment be, in any way, fraudulent or inappropriate in order to be treated as a preferential transfer under Bankruptcy law.  As with fraudulent transfers, it is important to note that Trustees pursue preferential transfers in very few cases, and only when the transfers are significant.  They are much more common in business cases.  Additionally, although many people considering Bankruptcy are concerned about preferential transfers, or have heard of a “90 day rule,” even where a Trustee does pursue preferential transfers is almost never has any negative impact on the debtor or a discharge.

Preferential transfers are governed by Section 547 of the Bankruptcy Code.  In order to recover a preferential transfer, the Trustee must show that 1) the transfer was made to or for the benefit of a creditor, 2) for payment of a debt, 3) while the debtor was insolvent, 4) within 90 days of the bankruptcy filing, or one year if the creditor was an “insider,” and 4) that allowed the creditor to receive more than they would have in a Chapter 7 case if the transfer had not been made.   In the example above, the hospital was a creditor that received a payment on an antecedent debt.  If the debtor filed a Chapter 7 case less than 90 days after the payment was made, and the debtor was “insolvent” (generally, unable to pay his or her bills, which is normally the case with debtors), and the hospital received more than it would have received in the Chapter 7 distribution (again, virtually always the case), the Trustee may try to recover the payment if it was significant.  Realistically, very few Trustees will try to recover such a transfer if it was $1,000 and many would not even seek recovery of a $10,000 payment.  It is simply too expensive to try to recover the payment and any funds recovered would be eaten up in the fees and expenses of the case.  Given that most individuals facing Bankruptcy are unable to make large payments to creditors, and have to use available funds for basic living expenses, Trustees rarely pursue these transfers in individual cases.  Even when they do, it is a matter only between the Trustee and the creditor and there are no negative ramifications to the debtor regardless of the outcome.

Note that the look back period for transfers to “insiders” is one year rather than 90 days.  While there is a formal definition of “insider” in the code, in most individual Bankruptcy cases those “insiders” are usually close relatives, such as a spouse, parents or children.  For example, if a person received an unsecured loan from her parents to use as a down payment for a home several years ago, and was dutifully paying back the loan at $500 a month right up until the time she filed a Chapter 7 case, the Trustee may have a claim against the parents for $6,000 (the total payments made within a year before filing).  Again, even this situation is uncommon in a personal Bankruptcy case and many Trustees would overlook the transfers because of the time and expense of pursuing the claims and keeping the case open.

Although preferential transfers can be much more complicated, and there are several defenses available for creditors who have received transfers, the bottom line is that personal Bankruptcy cases in which the Trustee pursues preferential transfers are few and far between and rarely will be a stumbling block for individuals who have to consider a Bankruptcy filing.  As always, it is important to consult a good Bankruptcy lawyer as soon as possible if Bankruptcy becomes a possibility and discuss all recent transfers with a lawyer before filing a case.