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Advance Consultation with Expereinced Bankruptcy Attorney Is Best Way to Avoid Pitfalls of Preference Statute

June 23, 2014 by  
Filed under Blog

Often a person facing the prospect of bankruptcy assumes it would be in their interest to pay off a debt to a friend or family member prior to the bankruptcy filing. Nothing could be further from the truth. These payment may be subject to capture by the bankruptcy estate. In other words, the representative of the bankruptcy estate can sue the recipient of the payments and take the money away from them. There are ways to protect assents in advance of a bankruptcy filing, but making a preferential payment is not one of them. Consulting with an experienced bankruptcy counsel early in the process will allow for the optimization of asset protection and exemption planning. Those who reside in Arizona should consult with an Arizona Bankruptcy Attorney because bankruptcy exemptions are based on the state of  residence.

In order to successfully establish a prima facie case for recovery of a preferential payment,, a plaintiff must prove that the payment was: (I) a transfer, (ii) of an interest of the debtor in property, (iii) made to or for the benefit of a creditor, (iv) for or on account of an antecedent debt, (v) made while the debtor was insolvent, (vi) made within 90 days or one year, in the case of an insider that (vii) resulted in the creditor receiving a greater distribution than it otherwise would have in a hypothetical chapter 7 distribution. Typically, a preference claim must be brought within twp years from the bankruptcy petition date to bring the preference action. The plaintiff bears the burden of proof in establishing all of the following elements of the prima facie case.

A transfer is defined by § 101 of the Code as “every mode, direct or indirect, absolute or conditional, voluntary or involuntary, of disposing of or parting with property or with an interest in property, including retention of title as a security interest and foreclosure of the debtor’s equity of redemption.” 11 U.S.C. § 101.The transfer sought to be recovered, or avoided, must qualify as a transfer of an “interest of the debtor in property.” 11 U.S.C. § 547(b). A transfer of an “interest of the debtor in property” will include the transfer of “all legal or equitable interests of the debtor in property as of the commencement of the case.” 11 U.S.C. § 541.The transfer must have been made to or for the benefit of a creditor, as the term “creditor” is broadly defined pursuant to § 101 of the Code.: The next requirement for establishment of a successful preference case requires that the plaintiff prove that the allegedly preferential transfer was made “on account of an antecedent debt.” 11 U.S.C. § 547(b)(2). To satisfy this requirement, the debt must have been incurred prior to the allegedly preferential transfer.

For the purposes of a preference action, the Debtor is presumed to have been insolvent during the 90-day period preceding the filing of the bankruptcy petition. 11 U.S.C. § 547(f). A defendant may offer evidence to rebut the presumption of insolvency, and the plaintiff bears the ultimate burden of proof as to the Debtor’s insolvency. : A determination of insolvency is based on a typical balance-sheet assessment as to whether the liabilities of the debtor exceed the value of its assets

The preferential transfer which the Plaintiff seeks to avoid must have been made within 90 days prior to the filing of the bankruptcy petition, or between 90 days and one year before the date of filing if the creditor is an insider of the debtor. While the Bankruptcy Code provides numerous examples of parties that would qualify as insiders of a debtor, the list is not exhaustive and a determination of a party’s alleged insider status is often left to the court. The legislative history of the Bankruptcy Code provides the following definition: “one who has a sufficiently close relationship with the debtor that his conduct is made subject to closer scrutiny than those dealing at arm’s length with the debtor.”

Pursuant to § 547(b)(5), the final element that must be proven in order to establish a valid preference requires that the transfer must have enabled the creditor to receive more than the creditor otherwise would have received if: the case were a case under chapter 7 of this title; the transfer had not been made; and such creditor received payment of such debt to the extent provided by the provisions of this title. 11 U.S.C. § 547(b)(5).The practical effect of § 547(b)(5)is to precludes recovery of a transfer made to a fully secured creditor because the secured creditor would not be deemed to have received more as a result of the transfer than it otherwise would have pursuant to a chapter 7 liquidation.


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