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What is a voidable preference in a bankruptcy proceeding?

New York businesses often have informal advance notice of a customer's plans to file a petition under either Chapter 7 or Chapter 11. In such cases, a creditor may attempt to persuade or coerce the debtor into paying off all or part of an existing or antecedent debt. These creditors may face an ugly surprise once the bankruptcy proceeding is underway: such payments may frequently be set aside as "voidable preferences" and the payment refunded to the bankruptcy trustee.

A voidable preference is a transfer of the property of the debtor to or for the benefit of a creditor made while the debtor is insolvent. The transfer must occur within 90 days prior to the filing of the bankruptcy proceeding. Payments to creditors who have "inside knowledge" of such a payment can be declared voidable if the transfer occurred within one year prior to the filing. The final part of the test is a showing that the transfer enabled the creditor to receive a greater portion of the debt than if the creditor had filed a claim in a Chapter 7 liquidation.

In order to avoid having a payment declared as voidable, a creditor must first demonstrate that the debtor was solvent when the transfer took place. The burden then shifts to the trustee to prove the debtor was insolvent at the time of the transfer. The rules governing voidable preferences contain several exceptions and qualifications that cannot be adequately summarized in this post. For example, methods used to determine the date of the transfer may vary with different types of assets. The dates of transfer for checks, real estate sales, garnishments and judgment liens are each calculated in a different way.

Anyone concerned about the consequences of making or receiving a payment on an existing debt before a bankruptcy petition is filed may wish to consult an experienced bankruptcy attorney. Such a consultation can provide a helpful analysis of the facts and law that will determine the resolution of the issue.

Source: U.S. Attorneys' Manual, "58. Avoidance Powers -- Preferences, Statutory Liens, Postposition Transactions, Preferential Offsets, Limitations," accessed on July 24, 2017

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