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 California, as in all states, the concept of preferential transfers is governed by federal bankruptcy law, specifically under the U.S. Bankruptcy Code. According to 11 U.S.C. § 547, a preferential transfer occurs when a debtor makes a payment or transfers an asset to a creditor within 90 days before filing for Chapter 7 bankruptcy (or within one year if the creditor is an insider), which enables that creditor to receive more than they would have in the bankruptcy proceedings. The trustee has the authority to recover such transfers to ensure equitable distribution among all creditors. This process, known as a clawback, is intended to prevent any creditor from gaining an unfair advantage over others. The trustee can file an action in the bankruptcy court to avoid these transfers and bring the assets back into the bankruptcy estate. It's important for debtors and creditors to be aware of these rules to avoid actions that could be reversed by a bankruptcy trustee.