Voidable preference definition
/What is a 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 through a Chapter 7 filing.
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Example of a Voidable Preference
Herring Corporation is struggling financially and is behind on several payments to its vendors. Knowing that bankruptcy is likely within the next few months, Herring decides to pay off a $100,000 debt it owes to Supplier X, a long-time business partner, while leaving other creditors unpaid. Two months later, Herring files for Chapter 7 bankruptcy. In this case, the bankruptcy trustee reviews recent payments made by Herring and identifies the $100,000 payment to Supplier X as a voidable preference. Because the payment was made shortly before the bankruptcy filing and favored one creditor over others, the trustee demands that Supplier X return the $100,000 to the bankruptcy estate, so the funds can be redistributed fairly among all creditors.
How to Defend Against a Voidable Preference Claim
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.