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All About Preferential Payments in Bankruptcy

By Phoenix Bankruptcy Attorney on November 6, 2023

The concept of “preferential payments” in bankruptcy is often misunderstood. It is vital to understand the legal definitions and criteria, how these payments affect creditors and debtors, and the importance of seeking legal advice for personalized guidance. Bankruptcy may allow for exceptions to preferential payment rules or provide defenses against preferential payment claims.

In the complex world of bankruptcy, preferential payments are just one piece of the puzzle. If you’re facing financial distress or navigating bankruptcy proceedings, it’s essential to consult with an experienced Phoenix bankruptcy attorney.

Preferential Payments Legal Definition and Criteria

Preferential payments, in the realm of bankruptcy, refer to payments made to specific creditors within a specified period leading up to the bankruptcy filing. For payments to be considered preferential, certain criteria must be met. These criteria include:

  • The payment must be made to a creditor.
  • The payment must be for a debt owed before the bankruptcy filing.
  • The payment must be made within a specific look-back period, usually 90 days prior to the bankruptcy filing (or one year for insider payments).
  • The payment must allow the creditor to receive more than they would in a Chapter 7 liquidation.

Implications for Creditors and Debtors

Preferential payments can have significant consequences for both creditors and debtors. Creditors who receive preferential payments may be required to return the funds to the bankruptcy estate. This is to ensure that all creditors are treated equally and in a fair manner during the bankruptcy process.

On the debtor’s side, it’s important to understand the potential for preferential payment recovery by the bankruptcy trustee. This knowledge can guide debtors in making informed decisions regarding their financial transactions leading up to bankruptcy.

Exceptions and Defenses

Debtors and creditors have the option to raise various defenses against preferential payment claims. It’s crucial to understand that not all payments made within the look-back period are automatically considered preferential.

The following are not considered preferential payments under bankruptcy law:

  • Ordinary course of business: Payments made in the ordinary course of business are often considered exceptions. These include regular, recurring payments that align with established business practices and are not intended to provide one creditor with an unfair advantage.
  • Contemporaneous exchange: Payments made as part of a contemporaneous exchange, where the debtor and creditor engage in a simultaneous transaction, may not be categorized as preferential payments. This could involve the purchase of goods or services with immediate payment.
  • New value: Payments that provide a new value to the debtor can be exempt. If the creditor supplies additional goods or services to the debtor after the initial payment, this can be considered as a new value, justifying the payment.
  • Subsequent advance: Payments made after the original transaction, considered part of a subsequent advance, are often not treated as preferential payments. For example, a lender extending additional credit to the debtor after the initial payment is made may not be subject to recovery.
  • Small payments: Some jurisdictions may have exceptions for small payments, recognizing that pursuing minimal payments in the ordinary business can be overly burdensome.

Common defenses include demonstrating that the payment wasn’t preferential because it met certain legal criteria. Debtors may also argue that they received reasonably equivalent value for the payment, making it a fair transaction. In some cases, the financial condition of the creditor may be such that the payment cannot be recovered.

These defenses can be complex and require professional legal counsel to navigate successfully. Consulting with an experienced bankruptcy lawyer is advisable to ensure that your interests are protected and that you fully understand the implications and potential defenses related to preferential payments.

Scale Your Financial Mountain with Hilltop Law Firm

If you’re seeking financial assistance and are considering filing for bankruptcy, Hilltop Law Firm offers personalized advice and guidance tailored to your unique situation. Our Phoenix firm understands the intricacies of bankruptcy law, and we’re here to help you set the record straight about issues such as preferential payments.

Don’t let misconceptions hold you back from the fresh start you deserve—call us today at (602) 466-9631 for a free consultation.

Posted in: Bankruptcy

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