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 Indiana, 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 1 year if the creditor is an insider), and that transfer allows the 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 clawback provision is designed to prevent any creditor from gaining an unfair advantage and to maintain the integrity of the bankruptcy process. If a trustee identifies a preferential transfer, they can file an action in the bankruptcy court to have the assets returned to the bankruptcy estate. The recovered assets are then redistributed in accordance with the priorities established in the Bankruptcy Code.