Voidable preference

A voidable preference occurs when there is a transfer of assets to a creditor shortly before a debtor files for bankruptcy protection. The recipient of these assets must return them to the bankruptcy estate. A voidable preference has occurred when the following conditions are present:

  • There is a transfer to a creditor, or for the benefit of the creditor.
  • The transfer relates to a pre-existing debt.
  • The transfer was made while the debtor was insolvent (which is assumed to be the case within 90 days of the bankruptcy petition date).
  • The transfer occurred within 90 days of the bankruptcy petition date or within one year in the case of a payment to an insider.
  • The transfer allowed the creditor to receive more than would have been the case if the debtor had been liquidated.

A creditor can defend against a voidable preference claim by proving that the transfer was made in exchange for new value provided to the debtor, which therefore would not reduce the amounts recovered by other creditors. Another defense is that the transfer was made in the ordinary course of business, based on relevant industry standards, which means that it was a scheduled payment that would have happened anyways. This latter exception is intended to keep trade creditors from being penalized.

A payment made to a secured creditor cannot be characterized as a voidable preference, since the payment would be paid in full in the event of a liquidation of the debtor.

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