What Is A Preference Payment In Bankruptcy?

Filing for bankruptcy can raise many questions about how past financial decisions may affect your case, and one of the central issues involves “preference payments”. In this article, we uncover….

• What a preference payment is in the context of a bankruptcy case.
• Whether preference payments apply to payments made to family members.
• How to avoid triggering preference payment issues prior to filing for bankruptcy.

What Is A Preference Payment In A Bankruptcy Case?

In simple terms, a preference payment is paying certain people back while other creditors go unpaid. For example, if you stop paying a company like Capital One but continue paying back family members or friends you owe money to, that could become an issue. It often depends on the amount involved. If you’re talking about borrowing $100 here or there, that generally wouldn’t cause problems.

But a larger payment can raise concerns. A common example might be receiving a tax refund and using it to repay a friend or family member who lent you money months earlier. For instance, you might say, I just got my tax refund—here’s $2,000 for the money you lent me six months ago.

When you attend your bankruptcy meeting, one of the questions you’ll likely be asked is whether you repaid any debts to friends or family members within the past 12 months. If the answer is yes and the amount is significant enough, the trustee may take action. In many cases, that means you may have to pay that money back to the bankruptcy estate.

If you’re unable to repay it, the trustee may even pursue the person who received the payment, since the money may be considered preferential.

There can be other situations where someone chooses to pay certain creditors more than others, but those usually don’t become issues unless something unusual happens, such as paying rent or other debts far in advance, which generally isn’t allowed.

Why Does Federal Bankruptcy Law Restrict Preferential Payments Before Filing?

The main reason comes down to how bankruptcy trustees recover money for the bankruptcy estate. There are only so many ways a trustee can collect funds to distribute to creditors. What the law tries to prevent is someone saying, I’m about to file bankruptcy, and I owe a lot of money that I can’t pay. Before I file, I’m going to move all my money to certain people so the court can’t reach it.

For example, imagine someone has $20,000 in their bank account and decides to pay that entire amount to family and friends before filing bankruptcy, so the court cannot access the funds. In that situation, two things have happened:

• Preferential treatment: Certain people were paid while others were not.
• Prejudice to other creditors: If the money had remained in the account, it could have become part of the bankruptcy estate available to creditors.

So the rules exist partly to protect creditors and partly to prevent people from taking advantage of the bankruptcy process. Trustees need ways to recover funds that can be distributed fairly, and preference payment rules help ensure that happens.

Alec Solomita, founder of Solomita Law, PLLC, is a Florida bankruptcy attorney who regularly helps individuals navigate the complex rules surrounding Chapter 7 and Chapter 13 filings.

Through years of experience representing clients in federal bankruptcy court, he has guided many people through issues involving insider payments, trustee reviews, and potential preference payment disputes. His practical, straightforward approach helps clients avoid costly mistakes before filing and protects them throughout the bankruptcy process.

If you’re concerned about how past payments may affect your case, contact Solomita Law, PLLC today to discuss your options and take the first step toward financial relief.

How Far Back Does A Bankruptcy Trustee Look For Preference Payments?

Generally, trustees look back 12 months when reviewing payments made to insiders such as family members or friends.

Do Preference Payment Rules Apply To Payments Made To Family Members Or Insiders?

Family members are the most common example of insiders. In most personal bankruptcy cases, insiders typically include family members or close friends. Your other creditors, such as credit card companies, lenders, or car loan providers, are simply listed as regular creditors.

Another example of a potential issue would be making unusually large or advanced payments to a creditor. For instance, if someone decided to pay a full year of car payments all at once before filing bankruptcy, that likely would not sit well with the bankruptcy court.

In business situations, the concept can work in a similar way. For example, if a business owner repaid a family member who loaned money to help start the business (but that person is not formally listed as a creditor or does not have a legal interest recorded in the bankruptcy filings), the trustee might question that payment. In that case, the trustee could potentially pursue the person who received the money rather than the debtor directly.

Can Bankruptcy Preference Issues Delay My Discharge Or Case Resolution?

Preference payment issues do not necessarily delay your discharge unless the trustee believes there was serious misconduct or fraud and objects to the discharge. More often, the issue affects how long it takes for the case to fully close. You may still receive your discharge on the normal schedule, but the case itself will remain open until the bankruptcy estate has been fully administered.

If money must be repaid to the estate because of insider payments, that process can take time. Most people do not have that money readily available, so they may need to enter a payment plan. In many cases, that plan may last 10 to 12 months. Once those payments are completed and the estate is fully administered, the case can finally be closed.

How Can I Avoid Triggering Preference Payment Problems Before Filing For Bankruptcy?

The simplest rule is this: if you decide to stop paying your debts before filing bankruptcy, you should stop paying them across the board.

What you generally cannot do is repay family members while leaving other creditors unpaid. For example, you shouldn’t choose to repay your parents while ignoring your credit card companies.

I always tell people that I understand the instinct to repay family first. If I were in the same position, I might feel the same way. Family members are real people, not large corporations. But doing so can actually put both you and them in a worse position during bankruptcy.

There are some exceptions. Secured debts, such as a mortgage or car loan, typically continue to be paid if you intend to keep the property. But unsecured debts should generally be treated equally before filing.

To avoid preference payment issues, in the 12 months leading up to your filing:

• Do not repay large personal loans to family or friends before filing
• Avoid making unusually large or advanced payments on debts
• Do not loan money to others during this time
• Do not attempt to prepay major obligations such as a year of mortgage or car payments

These types of actions are obvious to bankruptcy trustees, and they can result in money being recovered for the bankruptcy estate. That can make the process more difficult, especially if you no longer have the funds.

In serious situations, if the required payments to the court cannot be made, it could even affect your discharge. For that reason, it is always best to avoid these issues altogether when preparing to file for bankruptcy.

Still Have Questions? Ready To Get Started?

For more information on preference payment in bankruptcy, an initial consultation is your next best step. Get the information and legal answers you are seeking by calling (407) 255-7458 today.