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Avoidable Preference Litigation in Bankruptcy Court

In layman's terms, an avoidable preference is a transfer or payment made to a creditor by a debtor that the bankruptcy trustee later seeks to recoup for the benefit of the bankruptcy estate and repayment of the estate's creditors.  This is in accordance with the priority scheme prescribed by the Bankruptcy Code (as opposed to the unilateral preference of the debtor and/or the original creditor receiving the payment)Many creditors never want to enounter avoidable preference litigation because it usually means a loss of time and attorneys' fees that must be expended to defend such suits.

Avoidable Preference Litigation

The purpose of avoidable preference litigation and the rationale behind the term's inclusion in the Bankruptcy Code is to fairly distribute the debtor's assets to creditors in an orderly scheme. Under the bankruptcy system, the squeaky wheel does not and should not always get the grease. As such, an aggressive creditor cannot take a lion's share of the available assets in repayment of his claim on the eve of debtor's bankruptcy filing to the detriment of other creditors.

Section 547 of the Bankruptcy Code governs preferences and defines the dreaded term. The definition of an avoidable preference, or payment sought to be avoided or canceled by the bankruptcy trustee (hence the name), has five parts. In order to prevail in avoidable preference litigation, a bankruptcy trustee prosecuting such a case must successfully establish and prove by preponderance of the evidence each of the elements defined below.

Elements of an Avoidable Preference

A bankruptcy trustee may avoid a transfer of any interest in a debtor's property if all of the following elements are established:

  • The transfer was made to or for the benefit of one of the debtor's creditors.
  • The transfer was made for or because of an antecedent or prior debt of the debtor before the transfer occurred.
  • The transfer was made while the debtor was insolvent.
  • The transfer was made 90 or fewer days prior to the debtor filing his bankruptcy petition (or one year if the creditor receiving the transfer or payment in question is an insider of the debtor, such as a family member or business partner).
  • The transfer allows the creditor to receive more than she would have received in a Chapter 7 case from the debtor, the transfer had not been made, and the creditor received only those payments he or she was allowed to receive pursuant to the Bankruptcy Code, such as pro rata payments from the Chapter 7 trustee.