Avoid giving the money back: Bankruptcy Preference Actions

Avoid giving the money back: Bankruptcy Preference Actions

10.21.2015

Even in the recovering economy, many businesses will receive letters or lawsuits demanding return of payments received from a customer who has recently filed bankruptcy.  These are called preference actions, and it is becoming common for such actions to be filed against everyone who received payments during the preference period.

The basic concept is that a creditor who has received payment just before the debtor files bankruptcy has received “preferential” treatment over other creditors who did not receive payment, so the payment should be returned to the bankruptcy estate.

Bankruptcy Code § 547 defines a preference as a payment:

1.         Made on an antecedent (as opposed to current) debt;

2.         Made while the debtor was insolvent;

3.         To a non-insider creditor within 90 days of the filing of the bankruptcy;

4.         That allows 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.

There are several defenses to preference claims.  Three of the most common are as follows:

1.         Substantially Contemporaneous Exchange

If the payment or other transfer was intended by both parties to occur at the same time as the sale or transfer of something of value to the customer (for example, COD payments), then the preferential payment may be completely exempt from turnover.  Payment need not be immediate, but it should be relatively soon after the sale.

2.         Payments in the Ordinary Course

This defense requires that the creditor show, first, that the transaction occurred in the ordinary course of the customer’s business or financial affairs.  This requires establishing that there is nothing out of the ordinary regarding the services or goods purchased; i.e., the debt relates to the debtor’s business.  This factor is usually easily satisfied.

Second, the creditor must show that the transfer was made in the ordinary course of business or financial affairs as between the debtor and the creditor OR within the customer’s industry.  The court will look at the history of the accounts receivable between the parties, and ask whether the days to pay for the alleged preference are in line with the parties’ past transactions.  Other factors that the court will look at are the length of the parties’ relationship, whether the method of payments remained constant, and whether there were any unusual collection efforts by the creditor.

3.         New Value

The new value defense permits the creditor to protect payments we received during the preference period if the creditor gave new value to the debtor that remains unpaid.  For example, if the customer made a preferential payment to the creditor but then, after the payment was made but during the preference period, the creditor extended new credit to the customer, then the preference amount is reduced to the difference between the two. 

This is a very technical area of the law.  If you receive such a claim, you should contact an attorney immediately.

Your attorney will ask you for more information about the specific transactions mentioned in the complaint, as well as the history of the relationship with the customer.  Once this analysis is completed, then a resolution can hopefully be reached.

__________________________

Kenneth L. Perkins, Jr. specializes in business litigation and counselling.  Mr. Perkins has litigated cases in both state and federal courts at the trial court and appellate levels, as well as before related government agencies. Mr. Perkins has used various methods of alternative dispute resolution to his clients’ advantage, including arbitration, mediation and private judges.

Mr. Perkins' experience encompasses a wide range of business disputes. He has handled both simple and complex business disputes, including matters involving breach of contract, business torts, fraud, non-competition agreements, trade secrets, employee theft, collections, alter ego claims,  partnership disputes (general and limited), products liability (design and manufacture), intellectual property disputes (trademark, trade dress and copyright), bankruptcy preference claims, landlord-tenant, and employment.

Mr. Perkins has substantial experience in matters involving the printing and graphics arts industries. 

Mr. Perkins also serves as outside corporate counsel to not-for-profit trade associations and related entities (e.g., insurance agency, long-term disability plan, MEWA/ERISA plans).

Mr. Perkins received his B.A. from University of California, Irvine and his law degree from the University of Southern California School of Law.  His full bio and contact information can be found at http://musickpeeler.com/professionals/bio.cfm?id=368

Business Litigation Practice Group

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