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The Problem With Preferential Transfers in Bankruptcy

Filing for bankruptcy allows people to obtain significant relief from mounting financial obligations. Bankruptcy proceedings not only halt the collection of debts by creditors but also discharges certain debts regardless of whether or not they were actually satisfied. Such relief is available in both Chapter 7 “liquidation” and Chapter 13 “reorganization” bankruptcies.

However, some people try to game the bankruptcy system by making what are known as “preferential transfers.” This article examines the problem with preferential transfers and its legal consequences.

What Is Wrong With Preferential Transfers?

As mentioned above, there are two important forms of relief in bankruptcy. When a person files their bankruptcy petition, creditors may not start a legal action to collect on any debts the bankruptcy petitioner owes them until bankruptcy proceedings are complete. This is known as an “automatic stay.”

The second form of relief is known as a “discharge in bankruptcy” and releases the petitioner from responsibility for repaying certain debts. This discharge permanently absolves the petitioner from having to pay off those debts.

A preferential transfer occurs when the petitioner repays a debt shortly before filing their bankruptcy petition. By paying off a debt right before filing for bankruptcy, the petitioner is trying to ensure those creditors are paid in full, in case their debt is wiped out as a result of the discharge in bankruptcy.

Under federal bankruptcy law, the following actions may be considered to be preferential transfers:

  • Repaying more than $600 to family, friends, or business associates in the year prior to filing for bankruptcy
  • Repaying more than $600 in total to a creditor within 90-days before filing a bankruptcy petition

Although repaying debts is generally a good thing that the law encourages, favoring certain creditors over others is considered unfair and unjust.

Legal Ramifications of Preferential Transfers in Bankruptcy

Preferential transfers are cause for remedial action by the bankruptcy trustee. In Chapter 7 bankruptcy cases, the bankruptcy can undo a preferential transfer using its “clawback” power. Once the trustee in bankruptcy finds out about a preferential transfer, they can request the court to recover the payment from the preferred creditor.

For example, if the petitioner paid $1,000 to their sibling for a personal loan and filed for bankruptcy ten months later, the bankruptcy trustee can recover that $1,000 payment and use it to pay off other creditors with priority claims on the petitioner’s bankruptcy estate.

In a Chapter 13 bankruptcy case, the bankruptcy trustee does not recover the payments used in the preferential transfer. Instead, the trustee adds the amount to the amount the petitioner must repay their creditors under the Chapter 13 repayment plan what they paid in the preferential transfer.

Returning to the previous example, the bankruptcy trustee in a Chapter 13 case would not recover the $1,000 the petitioner paid to their sibling as a preferential transfer. Instead, the trustee would increase the amount the petitioner owes to priority creditors under the Chapter 13 repayment plan by $1,000.

As you can see, preferential transfers are frowned upon under bankruptcy law. If you get caught making a preferential transfer, the legal ramifications can cost you dearly.

Consult the Hope Law Firm for Legal Representation Today

If you have questions regarding a legal matter related to bankruptcy, you should seek the legal advice of an experienced attorney from the Hope Law Firm. Our attorneys have experience working on many legal issues, from Iowa family law to federal bankruptcy matters. We hold your legal rights in the highest regard and will work tenaciously to preserve your best interests.

Call the Hope Law Firm at (515) 298-5056 or contact our office online to schedule a case evaluation exploring your available legal options today.