Bankruptcy law aims to treat all unsecured creditors equally. When a debtor pays one creditor ahead of others shortly before filing, the trustee can "claw back" those payments and redistribute them. Section 547 defines when transfers are preferential and what defenses apply.
A preferential transfer is a payment or transfer of the debtor's property to a creditor, made before bankruptcy, that allows that creditor to receive more than it would have received in a Chapter 7 liquidation. The bankruptcy trustee has the power under 11 U.S.C. Section 547(b) to avoid (undo) these transfers and recover the funds for the benefit of all creditors.
The trustee may avoid any transfer of an interest of the debtor in property -- (1) to or for the benefit of a creditor; (2) for or on account of an antecedent debt owed by the debtor before such transfer was made; (3) made while the debtor was insolvent; (4) made -- (A) on or within 90 days before the date of the filing of the petition; or (B) between ninety days and one year before the date of the filing of the petition, if such creditor at the time of such transfer was an insider; and (5) that enables such creditor to receive more than such creditor would receive if -- (A) the case were a case under chapter 7... (B) the transfer had not been made; and (C) such creditor received payment of such debt to the extent provided by the provisions of this title.
The trustee must prove all five elements to avoid a transfer as preferential:
| Creditor Type | Lookback Period | Statute |
|---|---|---|
| Ordinary (non-insider) creditors | 90 days before filing | 547(b)(4)(A) |
| Insiders (family, officers, partners) | 1 year before filing | 547(b)(4)(B) |
Section 101(31) defines "insider" broadly:
If you paid back a family member or business partner within the year before filing, that payment may be avoidable as a preference even though it occurred more than 90 days before filing. This is one of the most common preference traps in consumer and small business bankruptcies.
Even if the trustee proves all five elements, the creditor can assert several defenses under Section 547(c). The burden of proof on defenses rests with the creditor.
The transfer is protected if the debtor and creditor intended it as a contemporaneous exchange for new value, and the exchange was in fact substantially contemporaneous. Example: paying cash for goods at the time of delivery.
The transfer is protected if the debt was incurred in the ordinary course of the debtor's business or financial affairs, and the transfer was made in the ordinary course of business or according to ordinary business terms. This is the most commonly asserted defense and protects routine bill payments. Under BAPCPA, the creditor needs to show only one of these two prongs (ordinary course between the parties, or ordinary business terms in the industry), not both.
If you have been paying your electric bill on time, in the same amount, by the same method, for years, and you continue to do so in the 90 days before filing, those payments are likely protected by the ordinary course defense. But if you suddenly paid off a year's worth of overdue electric bills in a lump sum, that payment is less likely to qualify.
The transfer is protected to the extent that the creditor, after receiving the preferential payment, advanced new value to the debtor on an unsecured basis. The new value must not have been separately secured by an otherwise unavoidable security interest. Example: a supplier receives a $10,000 payment, then ships $8,000 worth of new goods on credit. The preference exposure is reduced to $2,000.
The Chapter 7 trustee reviews the debtor's bank statements and payment history for the 90 days (or 1 year for insiders) before filing. If the trustee identifies significant payments to creditors, the trustee may send a demand letter to the creditor seeking return of the funds. If the creditor does not voluntarily return the payment, the trustee files an adversary proceeding (a lawsuit within the bankruptcy case).
Section 547 applies in Chapter 13, and the Chapter 13 trustee or the debtor can bring preference actions. However, these actions are less common in Chapter 13 because the debtor is already repaying creditors through the plan.
The debtor in possession (or a Chapter 11 trustee, if one is appointed) has the same avoidance powers. Large Chapter 11 cases frequently involve extensive preference litigation against hundreds of trade creditors.
If you are a creditor who receives a demand from a bankruptcy trustee to return a payment as a preference, do not ignore it. You may have valid defenses, but the trustee can file a lawsuit to recover the funds. Consult a bankruptcy attorney to evaluate your defenses before responding.
Preferences and fraudulent transfers are distinct concepts:
| Feature | Preference (Section 547) | Fraudulent Transfer (Section 548) |
|---|---|---|
| Intent required | None -- preferences are not about fraud | Actual fraud requires intent; constructive fraud does not |
| Lookback period | 90 days (1 year for insiders) | 2 years |
| Who receives the transfer | A creditor, on account of a pre-existing debt | Anyone (creditor, friend, family, entity) |
| Key question | Did the creditor get more than its fair share? | Did the debtor get fair value in return? |
The Supreme Court held that the ordinary course of business defense under Section 547(c)(2) applies to long-term debt payments, not just short-term trade debt. This expanded the defense significantly, protecting regular mortgage and loan payments from preference avoidance.
The Supreme Court held that a transfer by check is deemed to occur on the date the check is honored by the bank (not when delivered or mailed). This can be critical in determining whether a payment falls within the 90-day preference period.
| Section | Subject | Relevance |
|---|---|---|
| 547(b) | Elements of a preference | Five requirements the trustee must prove |
| 547(c) | Defenses | Nine statutory defenses for creditors |
| 548 | Fraudulent transfers | Distinct avoidance power with 2-year lookback |
| 550 | Liability of transferee | Who must return the avoided transfer |
| 546 | Statute of limitations | Time limit for bringing avoidance actions |
| 101(31) | Insider definition | Who qualifies for the 1-year lookback |
Check whether a prior filing bars your discharge under Section 1328(f), 727(a)(8), or 727(a)(9).
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