What are Preference and Insider Payments?
Timothy M. Hughes • May 18, 2020
Under bankruptcy law, all creditors of the same priority need to be treated equally by the debtor. When a debtor repays one creditor and not others, it is considered a “preference” because the debtor is providing special treatment to a single creditor. All creditors of the same priority need to be treated equally under bankruptcy law. If a debtor pays one person or one entity and not others, the bankruptcy trustee has the right to void that transaction and bring the money back into the debtor’s bankruptcy estate so that all the debtor’s creditors will be paid the same percentage. The preference period for a normal creditor (i.e. credit card companies) is 90 days versus one year for an insider because transactions with insiders are more closely scrutinized. The question of whether a creditor is considered an “insider” in a bankruptcy case is an important distinction.
If a debtor has repaid a creditor a significant amount of money before filing for bankruptcy, it is important to disclose the transaction(s) related to the payment(s) in detail. This includes identifying the payees who are insiders. The bankruptcy code defines an “insider” to include a relative of the debtor or a general partner of the debtor. And “relative” is defined to mean an individual related by affinity or consanguinity within the third degree as determined by the common law, or an individual in a step or adoptive relationship within such third degree.
Courts have also defined insider more broadly to include a close family friend (but not relative), Courts have also looked at whether there is a close enough relationship between the debtor and the creditor that their transactions should be scrutinized at more than regular arms-length transactions. The courts look at whether the creditor could exert any influence over the debtor. If the creditor has some control over the debtor, then the creditor could be defined as an “insider.”
In addition to possibly undoing preference payments described above, a bankruptcy trustee has Avoidance Powers to go back four years to undo a transaction if there was a fraudulent transfer or transfer for less than fair market value. The chapter 7 bankruptcy trustee is an individual appointed by the Department of Justice to oversee the administration of a chapter 7 bankruptcy case. The trustee’s main duty is to examine the debtor under oath to determine whether or not there are any assets to be administered for the benefit of creditors. In most chapter 7 bankruptcy cases, there are no assets for a trustee to administer. This is because the state of Illinois exemption laws provide debtors with the ability to protect a specific amount of personal property while going through the bankruptcy process. However, the trustee also has avoidance powers. These powers give him the ability to undo certain transactions if it was done under two specific scenarios: 1) Fraudulent Transfers -- an act(s) made with actual intent to hinder, delay or defraud creditors, and 2) Transferred Asset For Less Than Fair Market Value – an act(s) made for less than the fair market value by a debtor who was insolvent at the time of the transfer.
If you would like more details, please do not hesitate to call our office. Our office has been successful in helping consumers with collection problems for over 28 years. If you have a debt or tax problem, please contact me at (847) 705-9698 or thughes@lavellelaw.com
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