What Are Preference Actions in Arizona Bankruptcy Law?

If you are considering bankruptcy, you may wonder how the payments you make to certain creditors before bankruptcy might affect the bankruptcy.  You may even wonder if you should be making payments to anyone before bankruptcy.

At Yusufov Law Firm PLLC, we assist debtors in Mesa, Phoenix, and Tucson who want clear guidance. Here, we explain how pre-bankruptcy payments to creditors are treated in bankruptcy, and how they might affect your case.

What Are Preference Payments?

Preference payments refer to payments a debtor (i.e. the person filing for bankruptcy) makes to some creditors right before filing for bankruptcy. These payments may give certain creditors more money than others, bypassing the equal treatment that bankruptcy law aims to promote.  In other words, by making these payments to a particular creditor, the debtor is “preferring” that creditor to his or her other creditors ” A bankruptcy trustee is allowed to recover these funds, so that they can be divided among all creditors.  The point of these rules is to keep things fair by preventing a debtor from giving select creditors a bigger slice of the pie.

What Are Preference Actions?

A preference action is a lawsuit that the trustee brings against a creditor who received preference payments from the debtor.  The purpose of a preference action is to recover the preference payments that the creditor received from the debtor.  The debtor is not normally involved in a preference action.

Why Do Preference Actions Matter to a Debtor?

Since the debtor is not involved in preference actions, the natural question is, why do they matter to the debtor?  If you are considering bankruptcy, understanding preference actions can help you avoid costly financial mistakes.  Many people considering bankruptcy want to pay off favored creditors before filing the bankruptcy.  This could be a credit card that they would like to keep, a doctor that they like, or even a friend or family member.  However, because of preference actions, these payments can be undone by the bankruptcy trustee.  In other words, the person or company paid will not get the benefit of the payment.  So, the debtor who makes the payment ends up spending money without getting any benefit from the payment, because the person or company being paid will not be able to keep the money that could have been used by the debtor on other necessary expenses.

The Elements of a Preference Payment

Below are some guiding factors that courts typically rely on to determine if a payment to a creditor is a preference.

Key Requirements

First, there must be a transfer of your property for the benefit of a creditor. This can include direct cash payments, checks, or property titles. Second, the transfer must be on account of a debt the creditor already holds, rather than a new debt incurred right at that moment. Third, you must have been insolvent at the time of the payment. Fourth, the payment usually must happen within 90 days before filing your bankruptcy petition (or up to one year if the creditor is an “insider”). Finally, that transfer should result in the creditor receiving more than if your debts were handled under a Chapter 7 liquidation scenario.

The Role of Insolvency

Insolvency means that your total debts exceed the value of your assets. Absent proof otherwise, bankruptcy law presumes that debtors are insolvent during the 90 days leading up to a case filing. This presumption can save time for trustees by making it easier to assert that a payment qualifies as a preference.

Insider vs. Non-Insider Creditors

An insider might include a relative, a corporate officer, or a business partner who has a close relationship with you or your company. If a creditor is an insider, the trustee can typically seek to recover payments made to them within one year before filing. The logic is that debtors might be more inclined to pay family members or close associates first, so these transactions are scrutinized more closely.

In Arizona, state statutes regarding exemptions and property protections can factor into how the court views preference payments. While federal bankruptcy rules govern preference claims, Arizona law influences what property a debtor can protect from creditors. The existence of state-specific exemptions might help reduce risk if you face a possible preference claim.

Defenses Against Preference Payment Claims

If the trustee alleges that a payment meets the requirements of a preference, there are still possible defenses. These defenses often hinge on showing that the payment fits within regular business transactions or that new value was added after the payment occurred.

Ordinary Course of Business

This defense greatly benefits individuals and businesses who can show that their payments were made under normal invoice and billing patterns, without special treatment. The following points often come into play when deciding whether the payment is considered part of normal activities:

• Were the timing and manner of payment customary based on past invoices?
• Did the creditor or debtor drastically change payment habits during the months before bankruptcy?
• Were there any abrupt demands threatening to stop services unless paid immediately?

If the payment was consistent with regular billing routines, the trustee may not be able to recover it as a preference.

Contemporaneous Exchange for New Value

Under this defense, a payment is not a preference if the debtor received new value (such as goods or services) at the same time that the payment is made. Cash-on-delivery transactions are a classic example. The thinking is that the debtor is not simply paying a past-due debt, but getting something in exchange for the payment.  Importantly, payments on secured debt (such as a mortgage or a car loan) fall into this category, because the debtor is getting new equity in the house or car in exchange for the payment.  Regular payments on a mortgage, car loan, or other debt secured by property, are not considered preference payments.

Subsequent New Value

This defense applies when you make a payment, but then the creditor provides further goods or services after getting paid. If that creditor later supplies new value, it can offset part or all of the amount that qualifies as a preference. Here’s how it generally works:

1. You pay the creditor $1,000.
2. The creditor then delivers $800 worth of additional products before you file.
3. The trustee might only be able to seek recovery of $200, since new value offsets most of the payment’s impact.

Seeking Guidance on Preference Payments in Arizona

If you’re concerned about a possible preference payment claim in Arizona, Yusufov Law Firm is here to help. We assist clients in Tucson, Mesa, and Phoenix with clear, practical guidance in line with federal bankruptcy law. Call  us at (520) 745-4429 in Tucson or (480) 788-0098 in Mesa/Phoenix, or visit our Contact Us to schedule a consultation. We’re ready to help you protect your interests and move forward with confidence.