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What is a preference lawsuit in bankruptcy?

Section 550 of the U.S. Bankruptcy Code allows a trustee to sue creditors to recover any payments made by a debtor within the 90-day period prior to their bankruptcy filing. These actions, which as known as preference lawsuits, apply to payments that were made:

  • On a previously incurred (as opposed to current) debt
  • While the debtor’s liabilities exceeded their assets, rendering them insolvent
  • To a non-insider creditor

In addition, the creditor must have received more money than it would have had its claim been paid through the bankruptcy process. If they received over $600 in a lump sum or over multiple payments within 90 days of the bankruptcy action, it is assumed that a preference situation exists unless they would have received more during a bankruptcy disbursement.

Insider creditor payments

If a debtor makes a payment of $600 or more to an insider creditor while insolvent and the transaction took place within one year prior to filing for bankruptcy, it may be treated as a payment transaction if the insider receives more than they would have during the bankruptcy. Examples of insider creditors include friends, family members, or business partners who loaned the debtor money.

This situation can be uncomfortable for debtors, but they have options if they don’t want the trustee to file a preference lawsuit against a friend or relative. For example, they can:

  • Hold off on filing for bankruptcy until at least a year has passed since the payment
  • Reimburse the bankruptcy estate by paying the trustee the same amount of money as the preference payment. Some trustees will allow payment plans for those who can’t afford a lump sum
  • Hold off on paying the debt until they have filed for bankruptcy

Business debt payments

With business debtors, the trustee will only try to undo payments or property transfers that exceed $6,225 in value. If the payments are less, the creditor may be able to use the Small Commercial Preference Defense (Section 547(c)(9) of the Bankruptcy Code).

How does a preference lawsuit transpire?

Preference actions begin when a bankruptcy trustee sends a demand letter to the creditor who received payment. It explains the reason for the claim and requests immediate payment. In many cases, the trustee will settle for a reduced amount to avoid litigation.

If there is no settlement, the claim is filed with the U.S. bankruptcy court. If the trustee prevails, they will reclaim the money, add it to the bankruptcy estate, and include it in the distribution to unsecured creditors.

If you have questions or concerns about recent payments to any of your creditors, a New York bankruptcy attorney can advise you on whether a preference situation exists and what you should do to rectify the situation without jeopardizing your bankruptcy filing. Contact the law office of Jayson Lutzky at 718-329-9500 if you are considering filing for personal bankruptcy. Mr. Lutzky can help you determine in a free in-office initial consultation if bankruptcy is the right path for you.

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