Meaning
Transactions completed by a debtor shortly before entering bankruptcy that favor one creditor over others can be declared void by a court-appointed trustee. These preference transfers are reversed to protect the principle of equal distribution among unsecured creditors during liquidation. The recovered assets are returned to the debtor’s estate so they can be shared proportionally by the entire creditor pool.
Insolvency Context
Avoidance actions are initiated when there is evidence that the debtor was insolvent at the time of the transaction. The preference transfers must have occurred while the company’s liabilities exceeded its assets or when it could not pay its debts as they fell due.
Clawback Window
Statutory periods dictate how far back a trustee can look to find avoidable transactions. Under preference transfers rules, the standard clawback period is usually ninety days before the bankruptcy petition is filed. However, this window extends to one year if the creditor is an insider, such as a director or a major shareholder.
This extension reflects the fact that insiders have access to non-public financial information and might attempt to secure their own positions before the company collapses.
Defense Argument
Creditors can defend their payments by showing that the transaction occurred in the ordinary course of business. These preference transfers are protected if the payment followed the usual billing cycles and terms that the parties had historically used. Another common defense is the new value exception, where the creditor provided new goods or services to the debtor after receiving the payment.
