What is preference of credit?

It is the right held by a creditor to be preferred in the payment of his claim out of the debtors assets above others. In other words, it is the right to be paid first. Nature and Effect of Preference 1. Exception to the general rule Because, generally, you have to pay your creditors when the debt becomes due. There should be no rules as to who should be paid first. Preference applies only when there are two or more creditors with separate claims against a debtor who has insufficient property. Since it is an exception to the general rule, the law as to preferences is strictly construed. Does not create an interest in property Preference simply creates a right to be paid first from the proceeds of the sale of property of the debtor. It does not create a lien on the property itself, but merely a preference in the application of the proceeds of the property after it is sold. 3. The creditor does not have the right to TAKE the property or SELL it as against another creditor Preference is not a question as to who may take and sell property belonging to the debtor. Preference applies after a sale, and it is a question of application of the proceeds of the sale to satisfy the debt. 4. It must be asserted If the right claimed is not asserted and maintained, it is lost. If property has not been seized, it is open to seizure by another. 5. It must be maintained Where a creditor released his levy, leaving the property in possession of the debtor, thereby indicating that he did not intend to press his claim further as to that specific property, he is deemed to have abandoned his claim of preference. When are the rules on preference of credits applicable? The rules apply only where: 1. there are two or more creditors 2. with separate and distinct claims 3. against the same debtor 4. who has insufficient property.

There must be a proceeding such as an insolvency proceeding wherein the creditors can file their claims. The right becomes significant only after the properties of the debtor have been inventoried and liquidated, and the claims of the various creditors have been established. Because before that, you have no way of knowing who the creditors are, and you have no liquidated property out of which you can pay them. APPLYING THE RULES STEP 1: MAKE AN INVENTORY OF ASSETS List down all the assets of the debtor. Group these assets into two: the Preferred Group and the Free Property Group. Those assets with special preferred claims under 2241 and 2242 imposed upon them belong to the Preferred Group. Those without special preferred claims will constitute the debtors Free Property. Remember to take out property held by the debtor only in the capacity of trustee. He may have legal title to it, but the beneficial title and ownership actually belong to another person. Since the property does not belong to the debtor, they should not be included in the proceedings. The same goes for property of the AC of CPG, property held as lessee or usufructuary, etc. STEP 2: GROUP THE CLAIMS Make four groups (1) special preferred credits on movables, (2) special preferred credits on immovables, (3) ordinary preferred credits, and (4) common credits. Put the ordinary preferred claims under 2244 together. List them down according to the order under 2244, since 2244 already gives the order of preference. Remember, though, that labor claims are on top. Put the other credits not falling under these three together. These are the common claims. The usual example is a promissory note in a private instrument.

STEP 3: SATISFY THE SPECIAL PREFERRED CLAIMS First: Take the value of the specific movable/immovable upon which the preferred claim is imposed. Second: Pay the taxes due on the property. Third: Pay the preferred claim of the creditor. Fourth: If, after paying the taxes and other special preferred claims, there is an excess, take the value of the excess and add it to the debtors Free Property. Fifth: If the value of the specific property is not enough to satisfy the taxes and other special preferred claims, and there is a deficiency, follows these rules: a. If the deficiency is in a credit arising from a pledge, real mortgage, or chattel mortgage, put the deficiency in the ordinary preferred credits group. Why do we know right away that it is an ordinary preferred credit? It is a credit in a public instrument, so it is an ordinary preferred credit under (14) of 2244. You know its in a public instrument because it was treated at first as a special preferred credit, and the requirement under 2241 and 2242 is that these transactions be registered (for real and chattel mortgage) or be in a public document (for pledge). b. If the deficiency is in a credit arising from a transaction that is not in a public document or is not contained in a final judgment (ex: unrecorded sale), put the deficiency in the common credits group. STEP 4: UPDATE THE INVENTORY AND LIST OF CREDITS After you have satisfied all of the special preferred claims, update the following: 1. The inventory of assets You may have to add to the Free Property Group if, after satisfying the special preferred claims, you have an excess. Make sure that you

add the excess to the Free Property Group. Add up the entire value of the Free Property Group because this is what you will use to settle the ordinary preferred claims and the common claims. 2. The list of ordinary preferred claims. If there was a deficiency in satisfying the special preferred claims, the deficiency will be an ordinary preferred credit if it is notarized or is contained in a final judgment. 3. The list of common claims. If there was a deficiency in satisfying the special preferred claims, the credit will be a common credit if it is not notarized or contained in a final judgment. STEP 5: SATISFY THE ORDINARY PREFERRED CLAIMS List down all the ordinary preferred claims in the order in which they are listed in 2244. This is the order of preference among them. Most probably, there will be several credits in public instruments and final judgments. Arrange these by date. Those falling on the same date will enjoy equal preference and will share the balance of the free property proportionately. STEP 6: SATISFY THE COMMON CLAIMS Whatever is remaining of the debtors free property will be used to satisfy the common claims. Since these will not be enough to cover the debtors remaining liabilities (hes insolvent), the common creditors will share the balance in proportion to the amount of their credit, regardless of the date.