Understanding the risk of accepting a voidable preference

Most businesses in Maryland generally know when a customer is on the verge of bankruptcy. In such circumstances, the urge to collect past due obligations is powerful. Also, a person or company on the verge of filing a petition under Chapter 7 or Chapter 11 may plan to reorganize the business and wants to remain in the good graces of one or more creditors.

In such situations, the debtor may decide to make as significant payment on a past due account to a single creditor without considering the effect on other creditors. Any of these situations can give rise to what is known as a “voidable preference,” that it, a transaction that may be set aside by the bankruptcy trustee and the amount of the payment recovered from the creditor.

The federal bankruptcy code defines a preference as any transfer of the interest of the debtor in property –

  1. To or for the benefit of a creditor
  2. For or on account of an antecedent debt owed before the transfer occurred
  3. Made while the debtor was insolvent (the debtor is presumed to be insolvent during the 90 days preceding the filing of the petition)
  4. Made on or within 90 days before the date of the filing of the bankruptcy petition, or
  5. That enables the creditor to obtain a greater share of the debtor’s assets than it would if the petition had been filed under Chapter 7.

The trustee bears the burden of proving that the transfer created a preference as defined in the bankruptcy code. If the trustee prevails, the court will order the creditor who received the preference to refund the money or consideration to the bankrupt estate.

The rule against voidable transfers has a number of exceptions, and the issue of whether the transfer was in fact preferential can often be affected by state law. Anyone who is either considering accepting a payment from a party on the verge of bankruptcy or who is considering paying certain creditors before filing a petition may wish to consult an experienced bankruptcy lawyer for advice on whether the transaction will create a voidable preference.