Glossary
Preference Payment
A preference payment is a transfer a debtor made to a creditor on an existing debt shortly before filing bankruptcy that a trustee or debtor in possession may be able to recover for the estate.
Section 547 of the Bankruptcy Code lets a trustee, or a chapter 11 debtor in possession, recover certain payments made before bankruptcy so that creditors are treated more equally. In general, a payment can be avoided as a preference if it was made to or for the benefit of a creditor, on account of a debt that already existed, while the debtor was insolvent, within 90 days before the bankruptcy filing, or within one year for insiders, and if it let the creditor receive more than it would have in a chapter 7 liquidation. Insolvency is presumed during the 90-day period.
Creditors have defenses. The most common are the ordinary course of business defense, which protects payments made according to the parties' usual practice or ordinary industry terms; the new value defense, which credits goods or services the creditor supplied on credit after receiving a payment; and the contemporaneous exchange defense, for payments intended to be and actually close to simultaneous with delivery. The Bankruptcy Code also sets minimum dollar thresholds, adjusted periodically, below which transfers in business cases cannot be pursued, and venue rules that affect where smaller claims must be filed. A 2019 amendment also requires the trustee to exercise reasonable due diligence, taking into account the creditor's known defenses, before suing.
Here is a fictional example. A tile distributor, Mosaic Stone Supply, receives $40,000 from a struggling contractor on long-overdue invoices 60 days before the contractor files chapter 7. The trustee demands the $40,000 back as a preference. Mosaic shows that it shipped $15,000 of additional unpaid tile after receiving the payment, reducing its exposure under the new value defense, and argues the rest was within the parties' ordinary payment pattern.
Preferences matter to creditors because a payment that seemed like a collection success can come back as a demand months or years later. Keeping clear payment histories, credit terms, and shipment records helps a creditor defend such claims.
Example
Mosaic Stone Supply faces a $40,000 preference demand and reduces exposure by showing $15,000 of new value shipped after the payment, plus an ordinary course defense.