One of the most difficult conversations a bankruptcy attorney can have with a client is to explain the concept of bankruptcy “preference claims”. The conversation often arises when a client suddenly receives a letter (or worse yet, a lawsuit) in which someone is demanding that the client give back a payment it received several years ago from a company that subsequently filed bankruptcy. “How can that be!?” they ask. “They paid me for goods or services we provided to them, and they owed us the payments!” “Why do I have to give them the money back?”

Well, the difficult answer is that in certain circumstances the Bankruptcy Code does require that some payments the debtor made before filing bankruptcy have to be returned to the debtor. It sounds crazy, but the reason or public policy for this law is to ensure that all similarly situated creditors receive equal treatment when a bankruptcy is filed. Without such a law, a debtor could, prior to filing bankruptcy, “prefer” certain creditors by paying certain debts, yet not paying others. In the resulting bankruptcy case, the creditors who got paid are much better off than those who did not get paid. To prevent this disparity, Congress included in the Bankruptcy Code the law about preference payments. 11 U.S.C § 547.

Fortunately, there are several circumstances in which you do not have to return payments received prior to a bankruptcy filing. The Bankruptcy Code has a very specific and detailed definition of what a “preference payment” is. The Bankruptcy Code defines a preference as...