What Are Preference Payments in Bankruptcy?
A preference payment is a transfer made by a debtor to a creditor before filing bankruptcy that gives that creditor more than it would have received in a Chapter 7 liquidation. The Bankruptcy Code, at 11 U.S.C. Section 547, gives the bankruptcy trustee the power to "avoid" -- or undo -- these payments and recover the funds for the benefit of all creditors.
The preference system exists to enforce a core bankruptcy principle: similarly situated creditors should receive equal treatment. Allowing a debtor to favor certain creditors over others in the period leading up to bankruptcy undermines the collective distribution process.
The Five Elements of a Preference
Under 11 U.S.C. Section 547(b), the trustee must prove all five elements to avoid a transfer as preferential:
- Transfer of the debtor's property -- The payment must come from the debtor's assets, whether cash, check, electronic transfer, or other forms of property
- To or for the benefit of a creditor -- The recipient must be someone the debtor owes money to
- On account of an antecedent debt -- The payment must be for a debt that existed before the transfer, not a contemporaneous exchange
- Made while the debtor was insolvent -- Under Section 547(f), the debtor is presumed insolvent during the 90 days before filing, shifting the burden to the creditor to prove otherwise
- Enabling the creditor to receive more than it would in a hypothetical Chapter 7 liquidation -- In most no-asset Chapter 7 cases, unsecured creditors would receive nothing, so virtually any pre-petition payment to an unsecured creditor satisfies this element
The 90-Day and One-Year Lookback Periods
The trustee's avoidance power applies to transfers made within two distinct time frames:
- 90 days before filing -- For payments to arm's-length creditors such as credit card companies, medical providers, and other unrelated parties
- One year before filing -- For payments to "insiders" as defined in 11 U.S.C. Section 101(31). Insiders include relatives, business partners, and entities controlled by the debtor. The extended lookback period reflects the greater opportunity for collusion between debtors and insiders.
In Florida cases, the one-year insider lookback frequently arises when debtors repay loans from family members before filing. A debtor who pays back $10,000 to a parent six months before filing has made a recoverable preference, even though the 90-day period for general creditors has not yet been reached.
Common Preference Scenarios in Florida Cases
Florida Chapter 7 trustees regularly investigate and pursue preferences in these situations:
- Payments to family and friends -- Repaying personal loans to relatives is one of the most common preference triggers. Trustees examine bank statements for transfers to individuals during the year before filing.
- Paying down one credit card -- Making large payments to a single credit card while other debts go unpaid signals preferential treatment
- Catching up on a car loan -- Making extra payments to avoid repossession can constitute a preference if the payments exceed regular contractual installments
- Paying a divorce attorney -- Retainer payments to counsel within the lookback period are frequently scrutinized
- Repaying business debts -- Self-employed debtors who pay certain vendors ahead of others create preference exposure
Defenses to Preference Actions
The Bankruptcy Code provides several defenses that creditors (or the debtor, if the trustee is seeking to recover the funds from the debtor) can raise:
- Ordinary course of business -- Under Section 547(c)(2), payments made in the ordinary course of business or financial affairs of the debtor and the transferee are protected. Regular monthly payments on a car loan or credit card minimum payments typically qualify.
- Contemporaneous exchange for new value -- Section 547(c)(1) protects transfers that were intended to be and were in fact a substantially contemporaneous exchange. Paying cash for goods at the time of delivery is a classic example.
- Subsequent new value -- Under Section 547(c)(4), if the creditor extended new credit or provided new goods or services to the debtor after receiving the allegedly preferential payment, the preference amount is reduced by the new value.
- Security interest transfers -- Section 547(c)(3) protects security interests perfected within 30 days of the debtor taking possession of the collateral.
- Small preference exception -- For individual consumer debtors, Section 547(c)(8) provides that the trustee may not avoid a transfer if the aggregate value of all transfers to that creditor is less than $600. This threshold prevents trustees from pursuing de minimis recoveries.
How Trustees Discover Preferences
Florida trustees investigate preferences through several methods:
- Bank statement review -- Trustees request and analyze six months to one year of bank statements, looking for payments that fall outside normal patterns
- 341 meeting questions -- At the Section 341 meeting of creditors, the trustee will ask about payments to family members, large payments to specific creditors, and any transfers of property
- Tax return analysis -- Tax returns may reveal income paid to insiders or unusual deductions that suggest transfers
- Schedule review -- The debtor's schedules and Statement of Financial Affairs require disclosure of payments to creditors and transfers to insiders within the applicable lookback periods
Planning Around Preferences
If you are contemplating bankruptcy in Florida and have made or are considering payments that could constitute preferences, proactive planning is essential:
- Wait out the lookback period -- If you made a significant payment to a family member or creditor, waiting 90 days (or one year for insiders) before filing eliminates the preference risk
- Maintain ordinary course payments -- Continue making regular, contractual payments on all debts rather than accelerating payments to favored creditors
- Avoid selective repayment -- Do not pay back loans from relatives or friends in anticipation of filing bankruptcy
- Disclose everything -- Attempting to hide preference transfers from the trustee is far worse than the preference itself. Non-disclosure can result in denial of discharge under 11 U.S.C. Section 727(a)(4).
- Consult your attorney early -- An experienced bankruptcy attorney can identify potential preference issues and develop a filing timeline that minimizes exposure
The Trustee's Recovery Process
When a trustee identifies a preference, they typically send a demand letter to the creditor seeking voluntary return of the funds. If the creditor refuses, the trustee may file an adversary proceeding -- a lawsuit within the bankruptcy case -- to recover the payment. These proceedings are governed by Federal Rules of Bankruptcy Procedure Part VII and can result in a judgment against the creditor.
For Florida debtors, the practical consequence is that a family member or friend who received a preferential payment may be sued by the trustee to return the money. This creates significant family tension and is best avoided through proper pre-filing planning.
This article provides general educational information about preference payments in Florida bankruptcy and does not constitute legal advice. Consult with a qualified bankruptcy attorney to evaluate transfers made before filing.