Understanding How Preferential Payments Work in Bankruptcy

If you are considering bankruptcy, you have probably already come across a lot of new terms. One of the big ones to know about? Preferential payments.

They might sound harmless, but they can complicate your bankruptcy process in ways you may not expect. With Canada’s bankruptcy process, there is a big focus on treating creditors fairly. This means that every creditor should get their fair share, no matter what. Preferential payments can disrupt this balance—and they might come back to bite you if not handled correctly.

So, let’s break down what preferential payments are, how they might impact your bankruptcy, and what steps you can take to avoid them.

What Are Preferential Payments in Bankruptcy?

Preferential payments happen when you pay back some creditors over others right before filing for bankruptcy. Think of it like this: if you pay off a big chunk of money to a family member or clear a debt with one specific creditor while ignoring the rest, it is seen as “playing favourites” with your debt. In bankruptcy, this can raise questions and might even lead to that payment being reversed, since it is not considered fair to other creditors.

Legal Definition of Preferential Payments

In bankruptcy terms, there is a specific period leading up to your filing called the preference period. If you made large or unusual payments during this time, a trustee might consider those payments “preferential.”

The idea here is to make sure no creditor gets a better deal than others. Essentially, bankruptcy law is built around making sure the process is fair and that no one creditor gets a shortcut to the front of the line.

Examples of Preferential Payments

To make things clearer, here are some specific types of payments that can get flagged as preferential:

Payments to Family Members and Close Friends

It is normal to want to repay people who have personally helped you out, but paying back a family loan just before filing can be problematic. These payments can look like you are prioritizing family or friends, and they might be pulled back by the trustee.

Large Payments to Specific Creditors

If you decide to pay off one big debt to a specific creditor while leaving others unpaid, this can also get flagged. Even if the creditor is aggressive or pushing you for payment, giving them special treatment over others can be viewed as unfair.

Anything Out of the Ordinary

If you have made any unusual or large payments that stand out from your regular payment patterns, these can raise red flags. For example, if you typically pay small amounts toward your debts but suddenly make a large lump-sum payment to one creditor, it could be seen as suspicious. Even if the payment was made with good intentions, it may still be reviewed closely to make sure it is fair.

How Preferential Payments Can Affect Your Bankruptcy Case

Preferential payments can make things tricky in bankruptcy. When the trustee spots these payments, they might “claw back” or reverse them, which can slow down your case, make things more complicated, and even mess with the discharge of certain debts.

The Risk of Clawbacks in Bankruptcy

A “clawback” sounds intense, but it is just the trustee’s way of reclaiming payments that were seen as unfair. If you paid off one creditor over others, the trustee might pull that money back to share it fairly with all creditors. So, even if you thought you were getting ahead by paying off a debt, the trustee can undo that to keep things balanced.

Impact on Getting Your Debts Cleared

These payments can even affect whether some debts get cleared. Sometimes, debts that would have been wiped out in bankruptcy can end up sticking around if the trustee finds you made preferential payments. So, trying to “strategically” pay off certain debts before filing can actually backfire.

How Trustees Handle Preferential Payments in Bankruptcy

A bankruptcy trustee plays a big role in spotting preferential payments. They are essentially there to make sure the process stays fair. Here is what they typically do:

Trustee’s Power to Recover Funds

Trustees can ask for the return of funds if they identify any preferential payments. They will work to recover the money from creditors who received these payments so that it can be split more evenly across all your debts. In other words, even if you think a debt is behind you, a trustee can still pull it back into the case.

Investigating Suspicious Transactions

Trustees will also look at your financial transactions leading up to the bankruptcy filing to identify anything unusual. They will look for things like large, out-of-the-ordinary payments or transfers that do not match your normal spending habits. This is just part of the bankruptcy process, and it is their job to make sure everything looks fair for all involved.

Steps to Avoid Making Preferential Payments Before Filing

If you are thinking about filing for bankruptcy, here are some practical tips to avoid these kinds of payments:

Timing Your Payments Carefully

Being mindful of the timing of payments is key. If you know you are going to be filing for bankruptcy soon, try to avoid making big payments to specific creditors. Keeping things as consistent and regular as possible will help your case go smoothly.

Consulting with a Bankruptcy Attorney

Working with an experienced bankruptcy attorney can make all the difference. They can guide you on which payments might look suspicious and help you navigate the process without causing any unintentional issues. Their advice can be invaluable in ensuring you are making decisions that will not come back to haunt you later.

How Farber Can Help

At Farber, we know the ins and outs of bankruptcy, and we are here to guide you every step of the way. Our team can help you avoid tricky situations—like making preferential payments—that could complicate your case. If you are feeling overwhelmed, why not take advantage of our free consultation? We will give you expert advice that is tailored just for you.

Whether you are struggling with payday loans, working to get out of debt, or managing on a low income, Farber’s got your back. By understanding how preferential payments work and taking a few smart steps, you can make the whole bankruptcy process smoother. And remember, you do not have to go through this alone—we are here to help you find the best path forward.