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The act of an insolvent debtor who pays one or more creditors the full amount of their claims or a larger amount than they would be entitled to receive on a pro rata distribution.
For example, a debtor owes three creditors $5,000 each. All three are equally entitled to payment, but the debtor has only $12,000 in assets. Instead of paying each creditor $4,000, the debtor pays two creditors in full and pays the third creditor the remaining $2,000.
The Common Law does not condemn a preference. Some state statutes prescribe that certain transfers are void—of no legal force or binding effect—because of their preferential character. If a state antipreference provision protects any actual creditor of the debtor, the trustee in Bankruptcy can take advantage of it.
Bankruptcy law does condemn certain preferences. The bankruptcy trustee can void any transfer of property of the debtor if the trustee can establish the following:
- The transfer was "to or for the benefit of a creditor."
- The transfer was made for or on account of an "antecedent debt"—that is, a debt owed prior to the time of the transfer.
- The debtor was insolvent at the time of the transfer.
- The transfer was made within 90 days before the date of the filing of the bankruptcy petition or was made between 90 days and one year before the date of the filing of the petition to an insider who had reasonable cause to believe that the debtor was insolvent at the time of the transfer.
- The transfer has the effect of increasing the amount that the transferee would receive in a liquidation proceeding under chapter 7 of the bankruptcy law (11 U.S.C.A. § 701 et seq.). 11 U.S.C.A. § 547.
Other statutory provisions, however, create exceptions; if a transfer comes within an exception, the bankruptcy trustee cannot invalidate the transfer even though the aforementioned five elements exist.
n. in bankruptcy, the payment of a debt to one creditor rather than dividing the assets equally among all those to whom he/she/it owes money, often by making a payment to a favored creditor just before filing a petition to be declared bankrupt. Such a preference is prohibited by law, and the favored creditor must pay the money to the bankruptcy trustee. However, the bankruptcy court may give secured creditors (with a judgment, lien, deed of trust, mortgage or collateralized loan) a legal preference over "general" creditors in distributing available funds or assets. (See: bankruptcy)
PREFERENCE. The paying or securing to one or more of his creditors, by an
insolvent debtor, the whole or a part of their claim, to the exclusion of
the rest. By preference is also meant the right which a creditor has
acquired over others to be paid first out of the assets of his debtor, as,
when a creditor has obtained a judgment against his debtor which binds the
latter's land, he has a preference.
2. Voluntary preferences are forbidden by the insolvent laws of some of the states, and are void, when made in a general assignment for the benefit of creditors. Vide Insolvent; Priority.