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What is a voidable preference in bankruptcy?

For most residents and small businesses in Eastern Tennessee, the bankruptcy process appears to deal solely with the debts owed by the petitioner. One class of debts, however, focuses on payments made to creditors before the bankruptcy proceeding begins. These debts are called "voidable preferences" for the very good reason that certain payments to creditors may be voided by the bankruptcy trustee.

Most debtors assume that they can pay their creditors in any order they choose. The bankruptcy system imposes a different rule: the bankruptcy debtor cannot treat similarly situated creditors in different ways. In other words, the debtor may not accord some creditors preferential treatment before and during the bankruptcy proceeding.

Voidable preferences occur more frequently in business and commercial bankruptcies, but the rule also applies to personal bankruptcies. A voidable preference is any payment or transfer of value to a creditor within 90 days of the filing of the bankruptcy petition that satisfies four criteria:

  • The payment or transfer must benefit a creditor
  • The transfer must be used to pay an antecedent debt (a debt that existed before the bankruptcy petition was filed)
  • The debtor made the transfer while it was insolvent
  • The creditor received more value than it would have in a Chapter 7 proceeding if the transfer had never been made.

The debtor must disclose in its bankruptcy schedules any pre-petition transfers or payments of $600 or more made during the 90 days prior to the filing of the petition.

Armed with the list of $600 payments, the trustee can determine whether any of the payments meets the criteria for being a voidable preference. If the trustee deems a payment to be voidable, the trustee can initiate a "claw back" proceeding to recover the payment.

The voidable preference has several exceptions that must be considered when a debtor wishes to pay all or part of a debt. The advice of an experienced bankruptcy attorney may be useful in understanding the full effect of these exceptions.

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