Legal Definitions - preference

In bankruptcy law, a preference refers to a payment or transfer of assets made by a debtor to a specific creditor shortly before the debtor files for bankruptcy. The bankruptcy trustee has the authority to recover these payments, often called "preferential transfers," from the favored creditor. This legal mechanism exists to ensure that all creditors are treated fairly and equally, preventing a debtor from unfairly paying off certain creditors while leaving others with nothing just before bankruptcy proceedings begin. Generally, for a payment to be considered a preference, it must have been made within a specific timeframe (often 90 days for most creditors, or up to a year for 'insiders' like family members or business partners) and must have allowed the favored creditor to receive more than they would have through the standard bankruptcy distribution process.

• Example 1: Business Debt Repayment
  A struggling manufacturing company, "Widgets Inc.," knows it is on the verge of filing for bankruptcy. Sixty days before officially filing, the company pays off a $50,000 outstanding invoice to "Steel Supply Co.," a long-time vendor, ensuring Steel Supply Co. receives full payment. Widgets Inc. still owes money to several other vendors and banks.

  Explanation: This payment to Steel Supply Co. would likely be considered a preference. It occurred within the typical 90-day look-back period before bankruptcy, and it allowed Steel Supply Co. to receive 100% of what it was owed, while other creditors might only receive a fraction of their claims through the bankruptcy process. The bankruptcy trustee would likely attempt to recover the $50,000 from Steel Supply Co. to distribute it more equitably among all creditors.

• Example 2: Personal Loan to a Family Member
  "David" is facing severe financial difficulties and plans to file for personal bankruptcy. Eight months before filing, he repays a $10,000 personal loan to his brother, "Michael," even though he still owes significant amounts to credit card companies and other lenders.

  Explanation: This payment to Michael could be a preference because Michael is considered an "insider" (a family member). For insiders, the look-back period for preferential transfers can extend up to one year before the bankruptcy filing. David favored his brother by ensuring he was paid in full, while other creditors would likely receive less. The bankruptcy trustee could seek to recover the $10,000 from Michael.

• Example 3: Pre-Bankruptcy Asset Transfer
  "Creative Designs LLC" is insolvent and preparing for bankruptcy. Forty-five days before filing, the company transfers a valuable piece of design software, worth $15,000, to "Software Solutions Inc." in exchange for a $5,000 reduction on an old, unsecured debt that Creative Designs LLC owed to Software Solutions Inc.

  Explanation: This transfer of software could be a preference. It occurred within the 90-day window, and it allowed Software Solutions Inc. to receive a $15,000 asset (or a $5,000 debt reduction for an asset worth $15,000) for an unsecured debt. If the transfer hadn't happened, Software Solutions Inc. would likely have received only a pro-rata share of its unsecured debt during bankruptcy, which would have been significantly less than the value received. The trustee could potentially recover the value of the software from Software Solutions Inc.