The Bankruptcy Code considers a preferential transfer to be inappropriate.
The idea of a preferential transfer is that a debtor should not be allowed to pay, immediately before a bankruptcy filing, more than a creditor would receive in a Chapter 7 bankruptcy liquidation.
The rule is found in Bankruptcy Code Section 547(b) which is reproduced below
the trustee may avoid any transfer of an interest of the debtor in property
(1) to or for the benefit of a creditor;
(2) for or on account of an antecedent debt owed by the debtor before such transfer was made;
(3) made while the debtor was insolvent;
(A) on or within 90 days before the date of the filing of the petition; or
(B) between ninety days and one year before the date of the filing of the petition, if such creditor at the time of such transfer was an insider; and
(5) that enables such creditor to receive more than such creditor would receive if—
(A) the case were a case under chapter 7 of this title;
(B) the transfer had not been made; and
(C) such creditor received payment of such debt to the extent provided by the provisions of this title.
In simple language, a preferential transfer relates to
1. Payment to a creditor – someone to whom a bankrupt person owed money prior to a bankruptcy filing
2. Because of an antecedent debt – the debt was owed prior to the time in which money was paid (as compared to a situation in which the debtor makes a payment for goods or services which were provided at the same time as payment)
3. Transfer when debtor was insolvent – assets are less than liabilities ( negative net worth)
4. Either paid within 90 days before bankruptcy was filed or
Paid within one year to an insider – generally for an individual this is a relative
5. Creditor gets more money than he would receive if a Chapter 7 case was filed before the transfer.
Common situation for individuals:
a. Debtor pays Credit Card company $5,000 on 11/1/2016,
b. Debtor owed Credit Card company $5,000 from purchases in 2014 and 2015
c. On 11/1/2016, Debtor had $10,000 in assets for $45,000 in liabilities.
d. Debtor files for bankruptcy on 1/1/2017
e. Creditor would have received nothing in a bankruptcy filing. The $10,000 in assets are exempt property, which the debtor could keep and protect from creditor’s claims.
The preferential transfer rules don’t apply to transfers by individuals of under $600, or
transfers under $6225 if most debts are business debts.