Small businessmen in Kentucky who are pondering either a Chapter 7 liquidation bankruptcy or a Chapter 11 reorganization may seek to protect family members, friends or close business associates from the effects of a bankruptcy discharge by paying amounts owed to such persons or entities before filing the bankruptcy petition. Such payments may, if they meet six criteria set forth in the bankruptcy code, be voided by the bankruptcy court, and they may impose additional costs on the estate, thereby reducing the amount available to pay creditors. These payments, known as “preferences,” can pose a hazard in any business bankruptcy.

A payment to a creditor is a voidable preference if it meets these criteria:

  • A payment or transfer of something of value must occur.
  • The transfer is made for the benefit of the creditor.
  • The debt must have existed prior to the payment.
  • The debtor was insolvent at the time of the transfer.
  • The payment must have been made within 90 days prior to the filing of the petition (the look back period is 12 months if the creditor meets the definition of “insider”).
  • The payment enables the creditor to receive a greater portion of its debt than it would have received under the distribution pursuant to bankruptcy code.

The bankruptcy trustee has the power to initiate litigation to set aside the transfer and recover the funds or other assets that were transferred to the creditor.The bankruptcy code provides a number of defenses to the trustee’s claim of preference. If the payment is made for current services or goods (“new value”), it may not be deemed to be a preference. Also, transfers in the ordinary court of business, such as a regular payment for new inventory, are generally considered to be exempt from the voidable preference rules.

The advice of a lawyer who handles bankruptcy proceedings can often help avoid preference issues before they occur. A creditor may seek advice on how or whether to accept a payment from a debtor that may be a preference, or a debtor may be able to find a way to make a payment without having it later voided by the bankruptcy court.

Post Type: Topical

Source: FindLaw, “Understanding Bankruptcy Preference Law Just Saved My Business a Bunch of Money,” accessed on March 31, 2017