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 Vermont, as in all states, the concept of preferential transfers is governed by federal bankruptcy law, specifically under 11 U.S.C. § 547 of the Bankruptcy Code. This law states that certain transfers made by a debtor within 90 days before filing for bankruptcy (or one year if the creditor was an insider) can be deemed preferential. These transfers are made to a creditor that results in the creditor receiving more than they would have in a Chapter 7 liquidation case. The bankruptcy trustee has the authority to recover such transfers to ensure equitable distribution among all creditors. Vermont does not have specific state statutes that alter the federal rules on preferential transfers; therefore, the federal law would be applied in Vermont bankruptcy courts. If a trustee identifies a preferential transfer, they can file an action in the bankruptcy court to claw back the assets or funds into the bankruptcy estate. Debtors in Vermont considering bankruptcy should consult with an attorney to understand how these rules may affect their financial transactions prior to filing.