What is a preferential payment in bankruptcy?

A preferential payment is a payment made to a Creditor or Debtor Collector (someone you owe money to) shortly before filing for Bankruptcy.  For example, lets say you owe, Chase, Bank of America and Wells Fargo each $5000.  Last month, you withdrew $5000 from your 401k and used it to pay Chase back their $5000.  Since that payment, you have not paid Bank of America or Wells Fargo.  If you file bankruptcy today, the payment made to Chase is considered a preferential payment if no property or money is liquidated in your case and paid to your creditors.

The preferential payment rule

A Preferential payment is any payment of over $600 in aggregate to a creditor in the 90-day period prior to filing bankruptcy, while insolvent, and the payment allows the creditor to receive more than it would otherwise have received in your bankruptcy case.

Preferential Payments to Insiders

The same rule applies to insiders which include family, friends and business partners.  However, the period for insiders is 1 year as opposed to 90 days.

What happens if I make a preferential payment?

If you make a preferential payment prior to filing for bankruptcy the trustee can attempt to get that money back to distribute the payments evenly among all of your creditors.  In the above example, the trustee would divide the $5000 evenly among your creditors after costs and expenses.  If the payments were made outside of the 90 day and 1 year rule, the trustee would have to prove that you were insolvent.  If the payments were made with the 90 day and 1 year rule, the trustee would have to prove insolvency, meaning that your debts exceeded your assets at the time you made the payment.

Additionally, if you made preferential payments to defraud your creditors or hide money, this is illegal.  You can risk losing the benefit of a discharge and can be prosecuted criminally.