preferential payment
A payment made to one creditor over others shortly before bankruptcy — can be clawed back by the bankruptcy trustee.
Example
“The $5,000 paid to his brother 60 days before filing was a preferential payment the trustee reversed.”
Memory Tip
PREFERENTIAL — paying one creditor before filing can be reversed in bankruptcy.
Why It Matters
Understanding preferential payments is crucial if you are facing potential bankruptcy, as the trustee can recover funds you thought were safely paid out. This means creditors who received payments shortly before bankruptcy may have to return that money, which could affect your overall debt resolution strategy and creditor relationships.
Common Misconception
Many people believe that once they make a payment to a creditor, that money is gone and cannot be recovered under any circumstances. In reality, payments made within a certain window before bankruptcy filing can be legally reversed, meaning creditors may be required to return funds and rejoin the pool of unsecured creditors.
In Practice
Suppose you owe $50,000 to multiple creditors and realize bankruptcy is likely within six months. You pay your brother $10,000 to settle a personal loan just two months before filing. The bankruptcy trustee can claw back that $10,000 payment since it was made to an insider within the lookback period, and your brother must return the money to be redistributed among all creditors.
Etymology
From Latin 'praeferre' meaning to prefer — preferring one creditor over others before bankruptcy.
Common Misspellings
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