Legal Definitions - voidable preference

A voidable preference refers to a payment or transfer of assets made by a debtor (an individual or company owing money) to one of their creditors shortly before filing for bankruptcy. This transfer is considered "preferential" because it gives that particular creditor an unfair advantage, allowing them to receive more than they would have if the debtor's assets had been distributed equally among all creditors in a standard bankruptcy proceeding.

Because such a transfer unfairly favors one creditor over others, the bankruptcy court, through a trustee, has the legal authority to "void" or undo it. The trustee can then recover the transferred money or assets and add them back to the debtor's estate, ensuring a more equitable distribution among all creditors.

For a transfer to be considered a voidable preference, it typically must meet several conditions:

• It was made to a creditor for an existing debt.
• It occurred while the debtor was insolvent (meaning they were unable to pay their debts as they became due).
• It happened within a specific timeframe before the bankruptcy filing (usually 90 days for most creditors, or up to one year for "insiders" like family members, business partners, or company executives).
• It allowed the creditor to receive more than they would have in a standard bankruptcy liquidation.

Examples of Voidable Preference:

Scenario 1: A Company Paying a Favored Supplier Before Bankruptcy

Example: "RapidTech Solutions Inc." is facing severe financial difficulties and plans to file for Chapter 11 bankruptcy. Two weeks before the official bankruptcy filing, RapidTech's CEO authorizes a full payment of $75,000 to "Circuit Boards R Us," a long-standing supplier and a personal friend of the CEO, for outstanding invoices. Other suppliers, who are also owed significant amounts, receive no payments.

Explanation: This payment to Circuit Boards R Us would likely be considered a voidable preference. RapidTech Solutions Inc. was insolvent when the payment was made, it was for an existing debt, and it occurred within the 90-day preference period before bankruptcy. By paying Circuit Boards R Us in full, RapidTech allowed that supplier to receive 100% of its debt, while other creditors will likely receive only a fraction (or nothing) through the bankruptcy process. The bankruptcy trustee could sue Circuit Boards R Us to recover the $75,000, which would then be added to the pool of assets to be distributed more equitably among all creditors.

Scenario 2: An Individual Repaying a Loan to a Family Member

Example: David is overwhelmed by personal debt and decides to file for Chapter 7 personal bankruptcy. Six months before filing, he repays a $5,000 loan to his sister, Emily, who had lent him money several years prior. David makes this payment even though he knows he cannot afford to pay his other creditors, such as credit card companies and a student loan provider.

Explanation: This repayment to Emily could be a voidable preference. As David's sister, Emily is considered an "insider" under bankruptcy law. Transfers to insiders can be voided if they occurred up to one year before the bankruptcy filing. David was insolvent when he paid Emily, and this payment allowed her to recover her entire debt while other creditors will not. The bankruptcy trustee could seek to recover the $5,000 from Emily to ensure a fairer distribution among all of David's creditors.

Scenario 3: A Business Transferring Property to a Lender

Example: "Green Acres Farm," a struggling agricultural business, is on the verge of bankruptcy. To satisfy a loan from "Rural Bank" that was secured by a specific tractor, Green Acres Farm formally transfers ownership of the tractor to Rural Bank one month before filing for bankruptcy. The tractor is valued at $40,000, but Rural Bank was only owed $30,000, and Green Acres Farm has many other unsecured creditors.

Explanation: This transfer of the tractor to Rural Bank could be a voidable preference. Although Rural Bank might have had a valid security interest in the tractor, the *transfer of ownership* itself, made so close to bankruptcy while Green Acres Farm was insolvent, could be challenged. If the transfer allowed Rural Bank to receive more than it was owed (e.g., if the tractor was worth more than the debt), or if it was done to the detriment of other creditors, the trustee might argue it was preferential. The trustee could seek to recover the tractor (or its excess value) to ensure a more equitable distribution of assets among all creditors, especially if the bank ended up with assets beyond the value of its secured claim.