Responding to a Bankruptcy Preference Claim
As a bankruptcy attorney who mostly represents creditors, I am not infrequently asked to assist companies who have recently received correspondence demanding that they repay thousands of dollars of payments received from a now bankrupt customer because it's a "preference". Often this happens well into the bankruptcy proceeding and long after the creditor has closed its books on the account, perhaps even writing off a remaining balance as uncollectible. If you have been unfortunate enough to be tagged for a "preference", the most important thing to remember is that you still have options and it is not always necessary to just write a check for the amount demanded.
Bizpointer>>> As a practical matter, it is NEVER wrong for a creditor to accept a payment even if the creditor thinks it might be a "preference". For one thing, the failing company may last longer than you think and may not file until after the payment to you is outside the ninety day preference period. In addition, to recover, it is the debtor which must demonstrate its "insolvency" at the time the payment was made. Furthermore, there are a number of defenses which can be asserted which can wind up justifying the creditor's receipt of the payment. Finally, preference actions are typically matters especially susceptible to neogtiation and settlement which may allow creditors to keep a portion of the prefernce payment.
Bankruptcy Preference Defined. So what, exactly, is a "preference" and what should you do if you get one of these letters, or worse, actually get sued? Basically, a "preference" is a payment that allows the recipient to receive more than their fair share of the now bankrupt customer's available cash and assets. The Bankruptcy Code says that a "preference" must be repaid because it frustrates the underlying policy of federal bankruptcy law that similar creditors should be treated in a similar fashion. This policy is intended to discourage a mad grab by creditors that might accelerate a financially ailing company's slide into bankruptcy.
On a more technical level, section 547 of the Bankruptcy Code defines a "preference" as a payment
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On an antecedent (i.e. past due) debt owed to a creditor;
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Made while the now bankrupt customer was "insolvent";
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Within 90 days (or a year, if the creditor is an "insider" such as a shareholder, officer, or director of the bankrupt debtor, or another affiliated company) before the date the bankruptcy proceeding was filed; AND
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That allowed the creditor to receive more on its claim than it would have had the payment not been made and the claim paid through the bankruptcy proceeding.
Banks and other creditors holding collateral for a debt can wind up receiving a preference payment if they are owed more than the collateral is worth. However, it is unsecured creditors such as the ordinary trade creditor in the form of suppliers, product inventors, and service providers that are the most vulnerable. In addition, it is important to understand that a preference claim can be asserted against a creditor even if the debtor still owes money to the creditor after the payment.
How to Respond. The records of a company in bankruptcy are, not surprisingly, often disorganized and sometimes incomplete. As a result, the net for possible preference payments is usually cast far wider than the true universe of actual preference payments. Thus, once fingered as a possible preference payment defendant, it is crucial to do a thorough "preference analysis" to determine whether there is really any actual liability.
A bankruptcy and creditors' rights attorney has the skills and experience to assist with this crucial task of evaluating what the likely liability exposure is. Martindale-Hubbell's Counsel to Counsel magazine offers this helpful, but very brief, overview of action steps and conceptual considerations that should be undertaken by any company being confronted with preference allegations.
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The CMA Daily News offers several suggestions about how to avoid being in a preference payment situation by taking certain preventive action such as requiring payment in advance of supplying goods or services.
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Thomas Onder of the New Jersey Law Blog recommends that, before contacting your attorney, you should try to gather a full payment history for the period of at least the year before the payment was made. A copy of all invoices showing both sales and payments received during this period is essential to a good defense. In addition, copies of any correspondence (including e-mail), contracts, checks, or other evidence of payments received can be extremely helpful. If you can determine the number of days which generally elapsed between presentation of the invoices and receipt of payment and detect any patterns, that can also be useful.
How This Helps in the Defense of a Preference Action. A preference analysis can utilize this information and preventive action to determine whether there is in fact a defense to the demand for repayment of the alleged preference payment. Three of the most common defenses are:
Contemporaneous Exchange. In many cases, as the now bankrupt customer begins to have more and more severe financial problems, there will be times in which the need for a particular shipment of goods or services is so great, that there will be payment for that particular shipment. When the shipment of goods or services and receipt of payment for those goods and services happen more or less at the same time, there is said to be a "contemporaneous exchange", constituting an exception within the meaning of section 547(c)(1) of the Bankruptcy Code.
Ordinary Course of Business. Section 547(c)(2) of the Bankruptcy Code offers another defense if the payment was made in the "ordinary course of business or financial affairs" of the creditor and bankrupt customer in payment of a debt "incurred in the ordinary course of business or financial affairs" of the parties. Payment made "according to ordinary business terms" are also excepted. Thus, both the course of dealing between the parties as well as customs in the relevant industry can be important. Changes in the Bamkruptcy Code in the last few years has made it somewhat easier to rely upon this defense.
Subsequent New Value. Sometimes, even as a financially distressed company struggles for survival, it is able to induce creditors to continue doing business with it, perhaps on the strength of a promise to get everything caught up in the near future or a partial payment of the past due amount. If there are both payments and supplying of goods and/or services within the ninety day "preference period", it is likely that the "subsequent new value" defense found in section 547(c)(4) will be applicable at least to some extent. If applicable, the amount of "subsequent new value" extended will be subtracted from the amount of payments received.
All of these defenses depend greatly on the timing of invoices and payments and require a careful legal analysis of the creditor's documentation. Once a preference analysis has been completed by a bankruptcy attorney, you will have a much better idea of the strength of your case. This will then allow you to make a legally informed decision whether to fight or negotiate your best settlement quickly, thus minimizing the cost both in the amount paid back and attorneys' fees.
