Except for bankruptcy lawyers, most people, especially business people, cringe at the thought of bankruptcy. The concept of filing for bankruptcy protection is, to some extent, contrary to certain core business values such as paying your bills on time and being held accountable for your actions. Finding out that your customer has gone bankrupt owing you money (which you will probably never see) leaves a bitter taste.
The bitter taste of bankruptcy can get worse, however, when you learn that you have been sued by the bankruptcy trustee (the court appointed caretaker of the debtor’s property) to recover “preference payments” that your customer made to you within the 90 day period preceding the bankruptcy filing. Under Section 547 of the Bankruptcy Code, the bankruptcy trustee is empowered to bring an action to recover certain payments made by the debtor within this 90 day preference window. In short, not only could you be left stuck with a bad debt for the amounts your customer did not pay, you could also end up having to give money back!
With the increase in bankruptcy filings in recent years, we have defended numerous preference actions on behalf of our clients. Fortunately, there are some defenses available which can defeat the trustee’s preference claim.
If it can be demonstrated that the alleged preference payments were made and received in the ordinary course of the business relationship between debtor and creditor, they are not recoverable in a preference action. Stated differently, if the debtor had an established history of making payments to the creditor prior to bankruptcy, and if the payment history and the timing of payments are essentially consistent with the established practice between the parties, the payments will constitute “ordinary course” payments and need not be repaid. On the other hand, if the alleged preference payments were 30 days late, while all of the prior payments made by the debtor were generally made as agreed within 10 days of invoice, the preference payments likely would not be regarded as “ordinary course” payments (since late payments are outside the normal pattern between the parties) and could be recovered by the bankruptcy trustee in a preference action.
Another defense to a preference action is the “new value” rule. If it can be shown that the debtor received something new or additional in exchange for the alleged preference payment, this is a good defense to the preference action. (The debtor’s estate was enhanced.) If the debtor was simply making payments on old debt, however, the new value exception would not apply.
It is not uncommon for a bankruptcy trustee to file preference actions against all of the persons who received payments from the debtor within the 90-day period preceding the bankruptcy filing. Often the trustee will simply look at the debtor’s checkbook and sue all of those persons who received payments within the 90-day preference period. Many times the trustee has no idea whether the payments were made in the ordinary course of the relationship or whether new value was provided to the debtor. The burden is thus shifted to the creditor to defend the preference action aggressively and raise the defenses of ordinary course payment and new value whenever they are available.
Our goal in handling preference cases is to help our clients avoid having to return money to a defaulting customer. Many times a favorable settlement can be negotiated with the bankruptcy trustee. Call us if we can assist in this area.
— Kevin Palmer