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Understanding how voidable preferences work

On Behalf of | May 12, 2020 | Chapter 7, chapter 7 bankruptcy | 0 comments

When residents of Louisville contemplate bankruptcy, they look forward to the day when most, if not all, of their debts will be cancelled. “Discharged” is the lawyer word for this outcome. However, some debts cannot be discharged in bankruptcy, and anyone looking file a Chapter 7 petition should be aware of what can be an unexpected and unhappy outcome.

A person who is preparing to file a Chapter 7 petition may have several creditors, some of whom may be family members or close friends, and the debtor wants to ensure that they receive as much as possible in the bankruptcy. Likewise, a business on the verge of bankruptcy may have creditors that the business owner wants to pay as much as possible of any outstanding debts. One way of accomplishing these ends is to make payments prior to filing the petition.

Such payments are not absolutely forbidden by the bankruptcy code, but the trustee is given the power “based on reasonable due diligence in the circumstances of the case and taking into account a party’s known or reasonably knowable affirmative defenses under subsection” to avoid any transfer of property by the debtor if the transfer or payment:

  • Is for the benefit of a creditor;
  • For or on account of an antecedent debt owed before the transfer was made;
  • Made while the debtor was insolvent;
  • Made on or within 90 days of the filing of the petition; or
  • Made between 90 days and one year before the filing of the petition if the creditor was an insider.

The transfer must also enable the creditor to receive more than the creditor would receive in a Chapter 7 proceeding.

The trustee cannot avoid a transfer made for obtaining new value for the debtor. Debts made in the ordinary course of business, for example, the purchase of inventory, are also not voidable. Likewise, a payment of a debt for a domestic support obligation cannot be avoided by the trustee.

If such a payment is set aside by the trustee, the debtor’s plan to reorganize his or her finances may be significantly disrupted. Anyone thinking about filing a bankruptcy petition may wish to consult a capable bankruptcy attorney before making any payments to a creditor for a debt that existed prior to the filing of the petition.