Legal Definitions - insider preference

Insider preference refers to a payment or transfer of assets made by a debtor to a person or entity closely connected to them (an "insider") shortly before filing for bankruptcy. These transfers are often scrutinized by bankruptcy courts because they can unfairly favor the insider over other creditors, potentially allowing the insider to receive more than they would have if the assets were distributed equally among all creditors in bankruptcy.

Bankruptcy law allows these preferential transfers to insiders to be reversed or "clawed back" into the bankruptcy estate. This ensures a more equitable distribution of assets to all creditors, preventing the debtor from unfairly protecting or benefiting those closest to them at the expense of others.

Here are some examples illustrating insider preference:

• Example 1 (Corporate Context):

  A small manufacturing company, "Widgets Inc.," is on the brink of bankruptcy. Two months before officially filing for Chapter 11, the company's CEO authorizes a full repayment of a $100,000 loan to "SupplyCo," a company exclusively owned by the CEO's spouse. Meanwhile, other unrelated suppliers and lenders of Widgets Inc. are left with outstanding invoices and unpaid loans.

  How this illustrates insider preference: The repayment to SupplyCo is an insider preference because SupplyCo is owned by an insider (the CEO's spouse), and the payment occurred shortly before Widgets Inc. filed for bankruptcy. This action gave SupplyCo an unfair advantage, allowing it to recover its debt in full while other creditors received nothing. A bankruptcy court could potentially reverse this payment, requiring SupplyCo to return the $100,000 to the bankruptcy estate for distribution among all creditors.

• Example 2 (Individual Context):

  Sarah is facing overwhelming personal debt and decides to file for Chapter 7 bankruptcy. Six months before filing, she sells her antique car to her brother for significantly less than its market value, using the cash to pay off a personal loan she owed *him*. Her credit card debts and medical bills, however, remain unpaid.

  How this illustrates insider preference: This transaction could be considered an insider preference. Sarah's brother is an insider. By selling the car below market value and using the proceeds to pay him back, she effectively transferred value to an insider, allowing him to recover his loan while other creditors received nothing. A bankruptcy trustee might seek to recover the car or its market value for the benefit of all creditors, arguing that the transaction unfairly favored her brother.

• Example 3 (Business Partnership Context):

  "Tech Solutions," a partnership, is dissolving due to severe financial difficulties. One of the partners, David, transfers ownership of the partnership's most valuable server equipment to "David's Consulting," a separate business solely owned by David, just three months before Tech Solutions officially declares bankruptcy. David claims this transfer was to settle an old, undocumented debt Tech Solutions owed to David's Consulting.

  How this illustrates insider preference: This is an insider preference because David, as a partner, is an insider to Tech Solutions. By transferring valuable assets to his own separate company shortly before Tech Solutions' bankruptcy, he effectively prioritized his own entity's alleged claim over the claims of other legitimate creditors of Tech Solutions. A bankruptcy trustee would likely investigate and attempt to recover the server equipment or its value to ensure a fair distribution among all creditors.