The Practicalities of "Preferences"

 Posted on April 12, 2017 in Bankruptcy Law

Preferences can be dangerous but can also present potential opportunities. So although not all that common, they’re worth knowing about.

A "Preference” in Bankruptcy

In our last blog post we explained what a “preference” is in bankruptcy. It’s what it sounds like it would be. It’s a payment you make to a creditor before filing bankruptcy in preference to your other creditors. Then, after you file your bankruptcy case, under certain circumstances your bankruptcy trustee has the power to require the creditor to return the money you paid.

However, that money is not returned to you but instead to your “bankruptcy estate.” That’s the term for the pool of all your assets as of the moment you file your bankruptcy case. To the extent those assets are not “exempt,” or protected, the trustee distributes those assets among your creditors. Any money returned by a creditor as a preference is part of that pool of potentially distributed assets.

We said last time that a preference can be good or bad for a person filing bankruptcy. We’ll get into both kinds starting with our next blog post. But first today we get into a couple important practicalities about preferences.

Putting Preferences into Perspective

It’s important to realize that most consumer bankruptcy cases do not involve any preference payments. Or at least do not involve the trustee making a creditor give back such payments.

There are at least 3 reasons for that.

First, there are timing conditions for a payment to a creditor to qualify as a preference. For most creditors the payment must be made within the 90-day period before the bankruptcy filing. Lots of people who file bankruptcy aren’t paying a lot to their creditors in the last few months before filing.

Second, bankruptcy trustees will usually not pursue a preference if the amount of payment(s) is relatively small. How small depends on the circumstances. Most consumer bankruptcy cases are “no-asset” ones—all of the debtor’s assets are exempt, protected. If the trustee isn’t already getting other assets to distribute, the preference amount has to be surprisingly large to make the trustee’s time and expense worthwhile. Again, it depends on the circumstances. But usually it takes a thousand dollars or more in preference payment(s) if the trustee isn’t already pursuing other assets.

Third, even when the amount of the preference seems large enough, certain creditors may not be worth the trustee’s effort. The creditor may have gone out of business in the meantime, or may not have any meaningful assets. Especially if the trustee has to spend attorney fees to try to make the creditor pay and there’s a big risk it won’t, the trustee she may not be willing to try to chase down the preference. This is especially true if there are no other unprotected assets from which the trustee could pay its collection expenses.

Voluntary and Involuntary Preference Payments

As a debtor you can make a preferential payment either voluntarily or involuntarily. You could pay a creditor (before you file bankruptcy) by doing so voluntarily, intentionally. Or you could be made to pay involuntarily through a garnishment of wages or of a bank account, or some other aggressive method. Either kind of payment could be a preference, as long as all the other conditions apply.

If a payment was forced out of you, such as by garnishment, you’d welcome that payment being considered a preference. You may like the trustee making that aggressive creditor cough up that money. That would especially be true if the trustee turned around and paid that money where you’d prefer it to go.

If you paid a creditor voluntarily you may not care whether your trustee makes that creditor “return” the money. But if that creditor happens to be someone you have more than a debtor-creditor relationship with, you may really care. Having the trustee force your relative or friend to give up money you paid months ago could really hurt. It could hurt both your creditor relative/friend AND you.

In our next blog post we’ll get into these bad preferences, and how to stay clear of them.