One of the main jobs of a Chapter 7 trustee is to provide for an equality of distribution among general unsecured creditors so that all of these creditors are able to share equally when assets are available. The Bankruptcy Code has a number of provisions that assist the Chapter 7 trustee in accomplishing this goal. Under the bankruptcy code a “preference” is a transfer of money or of an asset before the bankruptcy is filed that has the effect of paying one creditor more than that creditor would have received if that transfer had not been made.
The Chapter 7 trustee has the power to “avoid” or reverse preferential transfers. Generally speaking there are two types of preferences. The first type is a preference made to an ordinary creditor. An example of this would include payments made to credit card companies. The second type of preference is a payment made to an “insider.” Examples of “insider” preferences are payments made to family members or business partners.
The Chapter 7 trustee has the authority to retrieve preferential payments from the parties to whom the payments were made. There is a look back period (the period during which a trustee is entitled to retrieve payments) of 90 days before the filing date of the bankruptcy case for ordinary preferences and one year before the filing of the bankruptcy case for insider preferences. This means that if the debtor paid money to American Express within 90 days of filing or the debtor paid the debtor’s mother back for a loan within a year of filing, the trustee can recover this money in order to distribute it to creditors on an equal pro-rata basis.
When a trustee attempts to recover a preference, the trustee will often first write a letter demanding that the payee turn the money over to the trustee. If the payee (the party who received the transfer) does not turn over the money, the trustee will often sue the person or company to recover the money. A trustee may accept a settlement offer to avoid the time and expense of litigation. For instance, if a debtor gave the debtor’s brother $5,000 to pay off a personal loan within a year of the debtor’s bankruptcy filing, the trustee may settle for a recovery of $3,000, instead of the seeking the full amount. A trustee has complete discretion regarding settlement options.
Even payments made from exempt funds may be considered preferential payments. For instance, if a debtor pays off a debt to his sister with money withdrawn from a 401(k), then the trustee is still entitled retrieve the money even though the trustee could not have gone after the original source of the money (the 401(k)). This scenario can be frustrating to the debtor, but it is the law. There is a section in the bankruptcy schedules where the debtor needs to disclose all preferences. If a debtor fails to disclose preferences, the debtor could be denied a discharge or could even face criminal charges.
The public policy behind allowing the trustee to recover preferential transfers is simple. It is not fair that one creditor gets paid something, even if the creditor is the debtor’s mother, while the rest of the creditors get less or even nothing. Bankruptcy law allows the trustee to recover this money so that it can be distributed fairly to all creditors, instead of just the ones the debtor wants to pay. It is important to discuss any preferences that the debtor has made with Justin M. Myers, a Utah bankruptcy attorney before filing for bankruptcy.