The issue of pre-bankruptcy asset transfers is discussed often; but most debtors aren't sure how a pre-bankruptcy transfer is determined to be preferential and reversible.
Below are a few standards that bankruptcy trustees use when determining if a pre-bankruptcy transfer is preferential and needs to be reversed:
Does It Benefit The Creditor?
If a debtor simply paid their minimum payment on a credit card before filing bankruptcy, this would not be considered a preferential transfer because it doesn't really benefit the creditor. Well, it doesn't offer an extra benefit over what they would normally receive outside of bankruptcy. On the other hand if the debtor had two credit cards and paid one off while allowing the other to go into default before filing bankruptcy, the bankruptcy trustee might consider it a preferential transfer of assets.
Was The Debtor Insolvent?
If a debtor pays off their credit card balance before they have become insolvent, the bankruptcy trustee may not consider it a preferential transfer which needs to be reversed. On the other hand, if the debtor was insolvent and paid off their credit card while failing to pay other creditors, then the bankruptcy trustee would consider that a preferential transfer that needs to be reversed. How do you define insolvency? Basically, insolvency is when you have more debts and/or expenses than you have income and assets.
The issue of insolvency can become a hot topic of debate, especially during business bankruptcy. For example, in the Tribune bankruptcy creditors accused the company of engaging in a buyout agreement when they knew that they were insolvent. However, the bankruptcy debtor denied that they were insolvent at the time. In the end, the point of insolvency was difficult to determine. It's the same for individual debtors. It may be difficult to prove that an individual debtor was insolvent when they paid off one debt instead of another.
Was The Transfer Made Recently?
Asset transfers made right before filing bankruptcy may be considered preferential by the bankruptcy trustee. However, "recent" is defined differently depending on who received the asset. For "normal" creditors such as a credit card company, a preferential transfers in the 90 day period prior to filing bankruptcy are suspect, while transfers made to pay off family (and friend) loans have a longer time period of a year and sometime more depending on extenuating circumstances.
Did The Creditor Get More Than His Fair Share?
The bankruptcy trustee will also look at whether the creditor received more than he would have in bankruptcy. For example, a credit card company owed $1,000 would probably receive nothing in Chapter 7 bankruptcy ; but the IRS owed $1,000 for the previous year's taxes would probably receive all of what is owed.