What Is A Preference Avoidance Action?

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A preference avoidance action is an action to avoid a preference; i.e., to undo a preference. This use of the word, “avoid” is a little unusual. It means to render null and void.

Preference avoidance is done through an adversary proceeding, the term in bankruptcy parlance for a lawsuit. The entity doing the avoidance action — whether it’s a trustee in a Chapter 7 bankruptcy case or the debtor in possession in a Chapter 11 bankruptcy case — files an adversary complaint in the Bankruptcy Court to initiate the adversary proceeding. The adversary proceeding continues until the judge enters a judgment, either denying the relief sought by the trustee, or requiring the recipient of the prebankruptcy preference payment to turn the money over to the trustee.

What Are The Elements Of A Preference Avoidance Action?

In order for something to be a preference, it has to satisfy the requirements that are found in section 547(b) of the Bankruptcy Code.

First, the transfer must have been made to or for the benefit of a creditor, which means that if the transfer was to someone who is not a creditor, then it was not a preference. (It might have been a fraudulent transfer, but it was not a preference.)

Second, the transfer must have been a payment on an antecedent debt, which is a debt that the debtor owed prior to the transfer. If the transfer took place before there was any debt, then it wasn’t a preference. (Again, it might have been a fraudulent transfer, but it was not a preference.)

Third, the transfer must have been made while the debtor was insolvent.

There are a couple of definitions of insolvency, the most common of which is that the sum of the debtor’s liabilities is greater than the sum of the values of the debtor’s assets. The slogan: If the debts exceed the assets, then the debtor is insolvent. However, sometimes a different definition is used because a debtor can be insolvent based on the asset/liability definition, but may still be able to service debts as they come due. The second definition is: The debtor is not making the payments on debts as they come due.

There is a (rebuttable) presumption that the debtor was insolvent during the 90-day prepetition window, i.e., the window of time prior to when the debtor files the bankruptcy petition.

Lastly, the transfer must have been made within the 90-day period prior to filing the bankruptcy petition for an ordinary creditor, and within one year prior to the filing for an insider creditor.

Subsection 547(c) of the Bankruptcy Code has a few defenses to preference avoidance, the most common of which is that the payment was a contemporaneous exchange for reasonably equivalent value.

Perhaps the most important take-away from this discussion is that prepetition planning is crucial to avoiding postpetition problems.

For more information on A Preference Avoidance Action, a free 20 Minute Phone Strategy is your next best step. Get the information and legal answers you are seeking by calling (562) 777-9159 today.