Legal Definitions - surrender of a preference

In the context of bankruptcy law, a surrender of a preference refers to a situation where a creditor, who received a payment or transfer of assets from a debtor shortly before the debtor filed for bankruptcy, must return that payment or asset to the bankruptcy estate. This return is often a mandatory condition for the creditor to be allowed to participate in the bankruptcy process and receive any other money they are owed from the debtor's remaining assets.

The original payment or transfer is considered a "preference" because it unfairly favored that particular creditor over others. Bankruptcy law aims to ensure that all creditors are treated equitably. Therefore, the bankruptcy trustee—the person appointed to manage the debtor's assets—has the power to "void" or cancel such preferential transactions. By requiring the creditor to "surrender" the preference, the trustee can gather all available assets to distribute them fairly among all creditors.

Here are some examples to illustrate this concept:

• Example 1: Preferential Payment to a Supplier

  Imagine a struggling manufacturing company, Apex Innovations, owes money to several raw material suppliers. A week before filing for Chapter 7 bankruptcy, Apex Innovations pays its oldest supplier, Global Materials Co., a lump sum of $25,000 for outstanding invoices, while other suppliers remain unpaid. This $25,000 payment to Global Materials Co. is considered a "preference" because it occurred shortly before bankruptcy and unfairly favored Global Materials over Apex Innovations' other creditors.

  The bankruptcy trustee would likely demand that Global Materials Co. "surrender" this payment back to the bankruptcy estate. If Global Materials Co. wishes to file a claim for any other money Apex Innovations might owe them, they would first have to return the $25,000. This ensures that the funds can be pooled with other assets and distributed more equitably among all of Apex Innovations' creditors.

• Example 2: Transfer of an Asset to a Friend

  Consider a person, David, who owes his friend Lisa $5,000. Knowing he is about to file for personal bankruptcy, David signs over the title to his valuable antique watch, worth $4,000, to Lisa as partial repayment just two months before his bankruptcy petition. The transfer of the watch to Lisa is a "preference" because it was an asset transfer made to a creditor shortly before bankruptcy, giving Lisa an advantage over David's other creditors.

  The bankruptcy trustee would identify this as a voidable transfer. If Lisa wishes to submit a claim for the remaining $1,000 David owes her (or any other debt), she would be required to "surrender" the antique watch (or its equivalent value) back to David's bankruptcy estate. This allows the trustee to sell the watch and distribute the proceeds fairly among all of David's creditors, rather than just benefiting Lisa.

• Example 3: Granting a New Security Interest

  Suppose a retail chain, Urban Boutiques, is facing severe financial difficulties. Three weeks before filing for bankruptcy, to appease one of its major lenders, City Bank, Urban Boutiques grants City Bank a new security interest (a legal claim) on all of its inventory, which was previously unencumbered. This means City Bank would have a priority claim on the inventory if Urban Boutiques defaulted.

  Granting this new security interest to City Bank just before bankruptcy is a "preference" because it gives City Bank a superior claim to Urban Boutiques' assets compared to other unsecured creditors. The bankruptcy trustee would likely deem this security interest "voidable." For City Bank to participate in the bankruptcy proceedings and assert any other claims it has against Urban Boutiques, it would need to "surrender" this preferential security interest, effectively giving up its special claim on the inventory. This action ensures that the inventory's value can be distributed more equitably among all creditors, not just City Bank.