What Is a Preference?

A preference is a unique claim in bankruptcy where a party can be sued to recover payments that a debtor in bankruptcy made to that party in the 90 days before a bankruptcy filing. A preference is not like a typical lawsuit where someone did something that caused harm to another. A party that acts in an entirely reasonable manner can get hit with a preference claim. In fact a party that did nothing at all but was still given priority by a debtor can be liable for a preference. A preference is a way of "clawing back" funds in a bankruptcy in order to make the bankruptcy "fairer" for all creditors. For a potential defendant a preference certainly does not seem fair!

The Basics of a Preference Claim

Preferences are created by statues, Section 547 of the United States Bankruptcy Code. (11 U.S.C. § 547). The preference statute gives several requirements for a preference claim. There must be:

1. A transfer, which is broadly defined and can be monetary or non-monetary.
2. of an interest of the debtor in property, which is also a very broad term.
3. to or for the benefit of a creditor, another broad term.
4. for or on the account of an antecedent debt, this is the first term that gives defendants some real relief. An antecedent debt is a debt that came before the payment. The critical part of this is that prepayments are not subject to preference claims.
5. made when the debtor was insolvent, but for the purposes of preference analysis, the preference statute creates a rebuttable assumption that a debtor is insolvent in the preference period below. A preference defendant can rebut the presumption of insolvency to defeat a preference claim, but that is often expensive as it requires experts to determine insolvency or solvency based on multiple definitions and complex accounting.
6. made within 90 days or one year, in the case of an insider, when you see the term "preference period" it almost always refers to the 90 days prior to a bankruptcy filing. For "insiders" (a term that gets very complex to define) there is a separate one-year period.
7. resulted in the creditor receiving a greater distribution than it otherwise would have in a hypothetical chapter 7 distribution, this element can also be important to creditors. Without getting too detailed, this means that debts that are secured may not be preferences. In bankruptcy, secured creditors get paid ahead of other creditors. So if you are a preference defendant that holds a statutory lien, you may have a full defense to a preference claim, or at least a defense up to the value of your lien. This is where you want to consult with a qualified bankruptcy attorney.

If these elements are met a "trustee," who may be the debtor, a post-confirmation trust in a Chapter 11, a Chapter 7 trustee, or a third party that has been given authority to pursue preference by the Court may sue to recover all the payments made in that 90-day preference period.

The Defenses Are How Creditors Win

These elements are often not hard to meet, but the real action in a preference case are with the statutory defenses.