Preferential Transfers in Bankruptcy

A preferential transfer is a payment made by a debtor to certain preferred creditors prior to filing bankruptcy. Florida and federal bankruptcy laws do not allow potential filers to favor certain unsecured creditors over others just prior to filing. The court can set aside a transfer it deems preferential.

If a debtor makes a payment to an insider within one year prior to a bankruptcy filing, the payment can be set aside as a preference by the bankruptcy court. Under Florida law, an “insider” is:

• a relative;
• a partnership in which the debtor is the general partner;
• a business in which the debtor is a director, officer, or person in control.

People that have a close relationship with a debtor, even if not technically relatives, can still be deemed insiders. For example, in one case (In re Bifani) a bankruptcy court found that a transferee was a “functional insider” because the transferee and the debtor had a close relationship.

In addition, preferential transfers made to anyone within 90 days prior to filing can also be set aside, whether or not the transferee is an insider.

Preferential Transfers Made by a Business

Preferential transfers also apply to businesses. For a business debtor, an insider includes the company’s officers and directors, people in control of the company, or relatives of any such people.

A debtor business can likely pay reasonable compensation to an insider without such payment being set aside. However, profit distributions or dividends paid to an owner can be deemed a preferential or fraudulent transfer.

Payments made in the ordinary course of business are not preferences, and payments made in exchange for “new value” are also not preferences. For example, a debtor who pays a supplier for goods or services received within the preference period will not be set aside.

Preferential Transfer vs. Fraudulent Transfer

A preferential transfer is different than a fraudulent transfer. A fraudulent transfer is a transfer made to a third party without receipt of consideration with the intent to hinder or delay collection or a transfer that renders the debtor insolvent. A preferential transfer, on the other hand, is a transfer made to an actual unsecured creditor for a bona fide debt that disadvantages other unsecured creditors.

Therefore, even if a transfer is not a fraudulent transfer, it could still be a preferential transfer.

Direct Transfer Not Required

A bankruptcy court can set aside a transfer that benefits an insider even if the transfer is not made directly to the insider.

Suppose a debtor owes money to a third-party creditor. The debtor’s family member had guaranteed the loan. The debtor makes regular payments to the third-party creditor within one year prior to filing bankruptcy. In this example, a bankruptcy court could find that the payments constituted preferential transfers to the family member even though the family member did not actually receive any money from the debtor.

Preferential Transfer Outside of Bankruptcy

The preferential transfer laws only apply in a bankruptcy context. The laws evaluate whether a debtor’s transfers prior to filing bankruptcy unfairly favored one creditor over the other.

On the other hand, outside of bankruptcy, a debtor can freely prefer one creditor over the other. While a transfer can still be set aside if it constitutes a fraudulent conveyance, a debtor is otherwise free to make payments to a bona fide, favored creditor, even if that creditor is an insider. This is just one example where a judgment debtor may have more asset protection options outside of bankruptcy.