12 Aug Chapter 7 Trustee’s Powers-What is a Preference?
A Chapter 7 bankruptcy is a liquidation, so a Chapter 7 trustee has the ability to sell assets and distribute the resulting cash to creditors (less a percentage and administrative costs). But the trustee has other powers, too, which can be more significant in many cases.
One of the goals of the entire bankruptcy system is “equality of distribution,” so that all creditors share equally in the limited assets that are available. The bankruptcy code has a number of provisions designed to equalize distribution among creditors, frustrate attempts by debtors and creditors to skew that distribution, or address a situation where such skewed distribution takes place through happenstance. None of those provisions is more important, or more frustrating to creditors and many debtors, than the preference provisions.
A preference is simply a transfer before bankruptcy that has the affect of paying one creditor more than that creditor would have received if the transfer had not been made. One of the things that is disclosed in a bankruptcy filing is whether any payments or other transfers were made shortly before filing. In addition, trustees will review records like bank statements, real property records, and the like, looking for such transfers. The trustee may make demand for the return of such assets, so that the value of the transfers may be shared with other creditors. The trustee also has the ability to file a civil suit and obtain a judgment for a preference.
It is important to understand that the preference statutes impose what lawyers call “strict liability,” i.e., a given set of circumstances gives rise to liability, regardless of the intent of the parties. The trustee does not have to prove that the debtor was trying to improve the position of the creditor, or that the creditor was trying to beat other creditors to the punch. If a payment or a transfer has the effect of improving one creditor’s position relative to other creditors, and no defenses exist, the trustee is entitle to recover the value of the transfer.
In general, a preferential payment to a third party is one that occurs within the 90 days prior to bankruptcy. Payments made within a year before bankruptcy to “insiders,” who are generally business partners, family members, and the like, can be set aside as preferential. There are some technical issues to consider–for example, a payment made by check is effective as of the date the check cleared, not the date on the check or the date it was mailed. There are also some defenses to preferences, usually available in a business rather than a consumer setting. Preferences can be voluntary payments, like a check sent in payment of an invoice, or involuntary, like attaching a bank account.
Preference recovery is generally a matter between the trustee and a creditor. When the creditor is a third party the debtor may not care very much. When the creditor in question is a relative, however, most debtors are very concerned indeed. One of the most common scenarios that lead to preference litigation is a debtor who tries to get debts to family members paid before filing bankruptcy. It is a natural thing to try to do. After all, no one wants their financial trouble to affect family members. But, that instinct can make plenty of trouble for debtors and those they try to pay. It is particularly frustrating when the debtor has taken money from something like a 401k plan or IRA, which a trustee cannot touch, used the money to pay a family member, and the result is a lawsuit against that family member. But that is just the most obvious kind of preference. They are not always that easy to identify; in fact, there are even “indirect” preferences. Trustees know them all–that’s what they are paid for.
A debtor needs someone with the same knowledge and experience on his side. One of the most valuable things an experienced attorney can do is prevent problems for you, and unintended consequences for your family members or business partners. It is also best to seek such advice before you make that payment, or transfer that asset. Lawyers are good at damage control, but we prefer to prevent a problem arising in the first place.
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