Bankruptcy preference claims – Real, but defensible preference claims

One of your regular customers unexpectedly went bankrupt a year ago.

After the initial disappointment, you filed your proof of claim with the bankruptcy court and hoped for some minimal payment sometime down the road.

You had almost forgotten about that customer until this morning, when you opened your mail. Then your jaw dropped.
The bankruptcy trustee is demanding that you repay it thousands of dollars your company received before the bankruptcy.

The letter must be a joke, right? Wrong.

The bankruptcy statutes allow a bankrupt’s estate to recover certain payments made by a debtor within 90 days before its bankruptcy.

Ironically, these payments are called “preferential transfers.”

To be a preference, a transfer must have been made for the benefit of the creditor, on account of the debtor’s antecedent (preexisting) debt, while the debtor was insolvent (liabilities exceeding assets), and which allowed the creditor to receive more than it would in a bankruptcy liquidation.

A creditor, already having to write off most if not all of an important receivable because of a customer’s bankruptcy, understandably views the possibility of having to affirmatively pay money to that customer’s bankruptcy estate as the Bankruptcy Code’s “madness.”

The preference law is designed to discourage creditors from racing to sue a failing debtor, to prevent a debtor from favoring some creditors over others, and to ensure equal distribution of a debtor’s assets among all creditors of the same type (i.e., secured, unsecured).

This, of course, is of little solace as you open a trustee’s demand letter or, even worse, a formal claim for repayment.

If there is any good news, it is that there are three main statutory defenses to having to repay a preferential transfer.

The first is where a customer’s payment was a “contemporaneous exchange” for new value given to the debtor. A COD payment for product is the best example of this situation.

The second is where a company gives “new value” to a debtor, after each payment received by the creditor within the preference period.

This is a “dollar for dollar” set off, which depends on the timing of payments and products (or services).

The third is where the payment was “in the ordinary course of business or financial affairs” of the debtor and the creditor, and made according to ordinary business terms.

This is not a “dollar-for-dollar” set off, but requires carefully crafted and detailed arguments as to the parties’ established, customary historical dealings both of the parties and their industry.

Preferential transfer demands are one of the commonest, most confusing and most complicated bankruptcy law issues facing creditors.

Faced with a preference claim, your FOS attorney should be your first call.