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5 Elements the Bankruptcy Trustee Must Prove to ‘Avoid’ a Preference

One of the more common things to happen in a New York bankruptcy case is the debtor will pay a favored creditor before filing the petition to give that creditor an advantage over the others in the bankruptcy proceeding. The bankruptcy code frowns on this behavior because it attempts to treat all creditors equally according to its own priorities, not debtors’. Consequently, a section of the code, § 547, is dedicated to these payments, called “preferences,” and lists the elements the trustee must prove in an adversary proceeding to compel the favored creditor to “avoid” (as in make “void,” not “evade” as the word is commonly used) the payment it received and transfer it to the bankruptcy estate.

The trustee may avoid the transfer of an “interest of the debtor in property” if it is:

(1)  To or for the benefit of the creditor

(2)  For an “antecedent debt” owed to the creditor before the transfer

(3)  Made while the debtor is “insolvent”

(4)  Made within 90 days of the petition, or between 90 days and one year of the petition if the creditor was an “insider” (family members, business partners, etc.)

(5)   More than the creditor would have received if the debtor’s case were filed in chapter 7

Some of these points are easier to establish than others. The first one speaks for itself: Money benefits people because it has value.

As for the second, “an antecedent debt” simply means it’s preexisting, unlike, for example, a contemporaneous exchange between two parties. A debtor might be able to disprove the payment is a debt if the transfer is a unilateral gift; however, those can be undone through “fraudulent conveyance” claims and not bankruptcy preference actions.

In the third point, “insolvent” in a preference action is strictly a balance sheet matter: Are the debtor’s liabilities greater than his or her assets? Section 547(f) of the bankruptcy code creates a presumption that the debtor is insolvent 90 days before bankruptcy.It’s pretty hard to disprove insolvency outside of an unusual situation, like if the debtor paid a creditor, was robbed, and suddenly couldn’t make his or her regular payments.

The fourth point reinforces the third: payments made more than 90 days before the bankruptcy filing usually receive less scrutiny than those within 90 days. However, trustees will investigate payments made to insiders, like family members, before filing. Often it’s best to wait one year before filing after the preference is made.

Finally, the fifth point is sort of a “no-harm-no-foul” clause that recognizes that if the creditor would have received the payment out of the bankruptcy estate anyway, then there’s no reason to avoid it.

Preferences aren’t just a problem for debtors. For creditors, being named in an avoidance action means the trustee will attempt to recover the money they received and return it to the bankruptcy estate, even when creditors had no idea a bankruptcy filing was forthcoming. Thus, experienced New York bankruptcy lawyers will find out if the debtor has made a preference and if necessary attempt to undo it outside of court before the petition is filed.

Creditors can also benefit from bankruptcy lawyer representation because a valid defense might be raised against the trustee, such as the payment being in the normal course of business. In other situations a lawyer can help the creditor can settle with the trustee for less than the value of the payment.

For answers to more questions about preferences, bankruptcy, the automatic stay, effective strategies for dealing with foreclosure, and protecting your assets in bankruptcy please feel free to contact experienced bankruptcy trustee actions Bruce Weiner for a free initial consultation.

Rosenberg, Musso & Weiner, L.L.P
26 Court St # 2211
Brooklyn, NY 11242, USA

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