Preferences are ironic because in Congress’ goal to be fair, it has created a statute that many, many people find to be terribly unfair. That is the preference statute. What it basically means is that if a creditor receives a transfer of property within 90 days before bankruptcy in exchange for paying a debt, under the right circumstances the trustee in bankruptcy can reach back and grab that transfer, can sue the creditor who received the money and get a money judgment against that creditor to recover the money. It’s an awesome and an awful power that a trustee has.
Why is it awesome? It’s awesome because it’s kind of a strict liability. The creditor did nothing wrong. All the creditor did was loan money or perform a service or ship goods and got paid, which was what was supposed to happen in the first place, but because it happened within the 90 days before the bankruptcy case, maybe years later, a trustee can come and say to that creditor, “You’ve got to give me that money back, even though you did nothing wrong.” That’s why it’s awesome and also why it’s an awful thing to be sued when you’ve done nothing wrong and you’ve just been paid for doing the work that you performed.
Why do we have these laws? The point of the preference laws is that there’s a presumption in bankruptcy that during the 90 days before a bankruptcy case is filed that debtor is insolvent. That means that there are more debts than there are assets to pay the creditors, so that means that some creditors are not going to be paid. So, if some creditors are not going to be paid, that means the ones that were paid were preferred over the ones that are not paid and because there’s this presumption of insolvency during those 90 days, Congress says, “That’s not fair. It’s not fair to the creditor that didn’t get paid that this other creditor did get paid, so at least theoretically, we’re going to pull back the money from the creditor that did get paid and redistribute it. We’re going to spread it around fairly, pro rata based upon their claims and give it proportionately to creditors.” Now, that’s what’s supposed to happen.
What typically does happen is that in a Chapter 11 or in a Chapter 7, there are large fees due to attorneys and accountants and a creditor’s committee may have an attorney, and so sometimes there are unpaid expenses of maintaining and administering the bankruptcy and those will get paid first from the money that comes in from these preference recoveries.
So what does that end up meaning? It means that the creditor who received the money in the 90 days before the bankruptcy does pay the money back, and that creditor ends up suffering just as much as the creditor that didn’t get that payment in the 90 days.
