Overview of Preference
In accounting and insolvency law, a “preference” refers to the favouring of one creditor over others by an insolvent debtor. This often occurs when the debtor pays off one creditor fully while neglecting others when there is no realistic prospect of paying everyone in full. Such actions skew the equitable treatment of all creditors.
In-Depth Definition
A preference occurs especially when an insolvent debtor, nearing bankruptcy, opts to settle a debt owed to a particular creditor in full, while other creditors remain unpaid or partially paid. In more technical terms, the preference must:
- Favor a particular creditor,
- Occur when the debtor is insolvent,
- Be followed by the debtor’s bankruptcy (individual) or insolvent liquidation (company).
If there is evidence that the debtor intended to improve the position of the preferred creditor, the courts can intervene. The court has the authority to:
- Order Restoration: Return the financial status to what it would have been if the preference had not occurred.
- Void Transfer of Property: Reverse the transfer of property given away or sold at undervalue.
Examples of Preference
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Example 1: A company nearing insolvency pays one creditor $100,000 to settle a debt, leaving other creditors unpaid. Later, the company enters liquid liquidation. The court may reverse this transaction upon reviewing that it was unfair to other unpaid creditors.
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Example 2: An individual, knowing that they are about to declare bankruptcy, transfers ownership of a high-value asset to a creditor to settle a specific debt while other creditors remain unpaid. The court can order the return of the asset to the bankrupt estate.
Frequently Asked Questions About Preference
Q: What determines if a transfer is considered a preference? A: A transfer is considered a preference if it puts a creditor in a more favorable position than other creditors while the debtor is insolvent and the action is followed by bankruptcy or liquidation.
Q: Can all preferential payments be reversed by the court? A: Not necessarily. The court considers the timing of the transaction (often within a specific period preceding bankruptcy or liquidation) and whether the debtor intended to prefer the creditor.
Q: What is the typical period under scrutiny for deemed preferences? A: Jurisdictions vary, but the scrutiny period is often the six months leading up to the debtor’s bankruptcy or liquidation.
Q: Can a preference include the transfer of properties? A: Yes, preferences can include transfers of monetary payments and properties.
Q: What is the goal of reversing preferential treatments? A: The goal is to ensure equitable treatment of all creditors so no single creditor unfairly benefits over others from the debtor’s payments or asset transfers.
Related Terms with Definitions
- Insolvent Liquidation: The process of winding up a company when it cannot pay its debts, often leading to asset sales and payment distributions to creditors.
- Bankruptcy: A legal process through which individuals or businesses unable to meet their financial obligations can seek relief from some or all their debts.
- Equitable Treatment: The principle that all creditors must be treated fairly and proportionately in distributing the insolvent estate’s assets.
- Voidable Transaction: A transfer or transaction that can be voided by the court, especially in insolvency scenarios, to maintain fairness among creditors.
Online References to Resources
- U.S. Bankruptcy Code - Preferential Payments
- Insolvency Service - Preferences
- Australian Government - Avoiding Preferential Payments.
Suggested Books for Further Studies
- “Principles of Bankruptcy Law” by Christopher F. Symes and Kirby Whiting
- “Corporate Insolvency Law: Perspectives and Principles” by Vanessa Finch
- “Understanding Bankruptcy” by J. D. Sprankling and W. R. Spratt
- “Bankruptcy and Debtor/creditor: Examples and Explanations” by Brian A. Blum
Accounting Basics: “Preference” Fundamentals Quiz
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