A preferential transfer is made when a debtor—prior to filing for Chapter 7 bankruptcy—pays off a certain creditor or group of creditors, which causes other creditors to get less in the bankruptcy.
Preferential transfers (also called preferences) are prohibited because they benefit one creditor at the expense of the others.
When a bankruptcy trustee learns of a pre-bankruptcy payment or transfer that constitutes a preferential transfer, the trustee can petition the bankruptcy court to have the money or assets recovered (a clawback) and included in the bankruptcy estate—allowing the recovered money or assets to be used for the benefit all of the creditors.
In Washington state, as in all states, the concept of preferential transfers is governed by federal bankruptcy law, specifically under the U.S. Bankruptcy Code. According to Section 547 of the Bankruptcy Code, a preferential transfer is any payment or transfer of an interest of the debtor in property made to a creditor within 90 days before the debtor files for bankruptcy (or within 1 year if the creditor was an insider), for a debt owed prior to such transfer, that enables the creditor to receive more than it would have received in a Chapter 7 liquidation case. If a bankruptcy trustee identifies a preferential transfer, they can seek to have the transfer undone, or 'clawed back,' to redistribute the recovered assets equitably among all creditors. This is designed to prevent any creditor from gaining an unfair advantage and to ensure the fair and equal treatment of all creditors in the bankruptcy process. The trustee's ability to recover preferential transfers is subject to certain defenses and exceptions, such as transfers made in the ordinary course of business or for new value.