The preference provisions contained in the current version of the federal bankruptcy law have their origins in England over 400 years ago. They first appeared in American legislation in 1841. Although the law has undergone a number of changes over the years, the objectives of the law have not changed. The primary purposes of the preference law have been and remain twofold:
- To guard against the debtor favoring one creditor over another as it slides into bankruptcy, and to provide for a re-distribution of the transfers made to those creditors; and
- To discourage creditors from racing to the courthouse as the debtor’s financial condition deteriorates.
In reality, the preference law may do little to discourage creditors from undertaking collection activity. Many would also argue that while the stated purpose of re- distributing money paid to creditors that have been preferred is perhaps noble, the law is fatally flawed. In particular, those arguing against the law point out that it draws into its net creditors whose claims go beyond what the statute was intended to (or should) cover, it discourages creditors from working with debtors when the debtor gets into financial trouble, and it falls far short of equitably distributing avoided payments among the creditor body. As to this last point, there are many instances where creditors have been forced to pay back money received shortly before a bankruptcy filing to find out that that money will not be re-distributed so as to even out the distribution among the pre-petition creditors but instead will be used solely for the purpose of paying the lawyers, accountants and other administrative claims in the case.
Overview of the Statute
In its simplest terms, the preference law allows a bankruptcy trustee (and other authorized individuals or entities) to recover for the benefit of the bankruptcy estate payments made to creditors shortly before a bankruptcy filing. The preference law is contained in section
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547 of the Bankruptcy Code and is essentially divided into two parts—the elements of the claim that must be proved by the trustee, and the defenses that may be raised by the defending creditor. As will be discussed, most preference disputes focus on the defenses. Section 547 is reproduced at the end of these materials.
Who May Bring a Preference Claim
The preference statute gives the bankruptcy trustee the power to bring a preference claim. Under section 1107 of the Bankruptcy Code, however, debtors in possession in chapter 11 cases are granted most of the powers of a trustee, including the right to sue to recover preferences. Pursuant to a plan of reorganization or court order, other parties—such as a creditors’ committee or a plan administrator—are sometimes granted the power to recover preferences on behalf of the estate. For the purposes of simplicity, these materials will refer to the party bringing the preference action or making the preference demand as the trustee.
To read the entire “Defending Bankruptcy Preference Claims” article, download the PDF below: