What Is a ‘Voidable Preference’ in Bankruptcy?

Let’s imagine that you own and operate a business in Rockland County. You have a customer who owes you money for goods that were bought at various times during the last year. You learn that the customer is experiencing financial difficulties and may have trouble paying his debts. You take the obvious action and ask the customer for payment. The customer pays one-third of what he owes and promises more later. Instead of “more,” however, the customer files a bankruptcy petition two weeks later. Bad news, but at least you were paid some of what the customer owes. You shrug and think things could be worse. You file your notice of claim for the balance owed to you and wait. But instead of receiving money from the bankruptcy trustee, you receive a federal court complaint seeking to recover the money paid to you before the bankruptcy. How can this be?

The answer is provided by 11 U.S.C. §547 — the section of the Bankruptcy Code that deals with voidable preferences. The payment that you received before the bankruptcy petition was filed is called a “preference,” or, to be more accurate, a “voidable preference.” A preference is a payment by the debtor that gives one or more creditors preferential treatment over other creditors.

The Bankruptcy Code defines a voidable preference as a payment to or for the benefit of a creditor on account of a debt owed by the debtor and made while the debtor is insolvent. The code creates a presumption that the debtor was insolvent 90 days before the bankruptcy petition was filed. Thus, any payment to a creditor to retire all or part of a debt made during this period can be voided by the trustee without proving that the debtor was insolvent. The same rule applies to payments made when the debtor was in fact insolvent, even if the payment was made before the 90 day period begins to run. A payment by the debtor to a creditor for new value as opposed to payment on a prior obligation is generally not considered a voidable preference.

The law governing the definition of a voidable preference is very complicated. Anyone who has been charged with accepting a voidable preference may wish seek advice on the numerous exceptions to the general definition of a preference and on strategies for defeating the trustee’s claim that a payment was a voidable preference.