Understanding and Avoiding Preference Liability

Think that's disappointing? Just wait until insult turns to injury and you find yourself on the receiving end of a letter or a lawsuit demanding repayment of the paltry amount you received from the bankrupt company during the 90 days prior to bankruptcy. As the defendant in a debtor or trustee's action to avoid and recover a preferential transfer (a “preference”), you may be forced to disgorge money to the debtor's bankruptcy estate.

Notwithstanding the sometimes harsh feeling that results from being the target of a preference claim, the policy goal underlying a trustee or debtor's right to avoid and recover preferences makes sense. The general concept is to avoid “unusual” transfers made on the eve of bankruptcy, so that all creditors are placed on an equal footing and so that no single creditor is preferred by having received more than it would have in an orderly liquidation of the debtor. For example, assume that you and another creditor are each owed $50,000 by the debtor and, two days prior to the bankruptcy filing, the debtor pays the other creditor in full but pays nothing to you. You hold a claim that is worth little if anything while the other creditor has already been made whole and is owed nothing. Preference law is designed to force the other creditor to disgorge the preferential transfer and return it to the bankruptcy estate to be shared by all of the bankrupt's creditors.