Being a creditor that isn’t getting paid can sometimes feel like a losing battle. Often, the worst-case scenario happens after a creditor has finally received some payment only to have the debtor file for bankruptcy and then, all of the sudden, the trustee in bankruptcy wants that money returned!
Under the Bankruptcy Code, this is called a preference claim and it happens all the time. The bankruptcy trustee can claim entitlement to funds received by a creditor in the 90 days before a bankruptcy filing, as a “preference,” if the amount received is more than the creditor will ultimately be entitled to receive from the debtor during the bankruptcy. Of course, not all bankruptcies lead to debtors asserting a preference claim. But a preference claim can certainly put a creditor in an unexpected financial situation.
Whether you will receive a demand to return an alleged preference payment depends, in large part, on actions taken after the debtor's bankruptcy filing. As a general rule, preference claims must be filed within two years of a bankruptcy filing, but that deadline can be longer in certain circumstances. One of the primary indicators of an impending preference claim is whether the debtor-company will be reorganized or liquidated. If the corporate debtor is being reorganized, preference claims are less likely to occur. In contrast, if it is being liquidated, preference claims are more likely to arise.
Although preference payments usually involve the payment of cash by the debtor to its creditor, a wide variety of transfers may qualify as a preference. Preference claims may seek to recover direct payments, reimbursements, escrow agreements, third-party payments, liens, savings certificates, real estate, or other assets.
What should a creditor do if faced with a preference claim? There are several things you can do to improve your odds of avoiding disgorgement of any or all of the alleged preference:
- Stay Apprised. If one of your customers or vendors goes into bankruptcy, track its progress. Things to watch: Is the business being reorganized? Is the business being liquidated? Is a creditors’ committee being assembled? These events indicate the likelihood of a preference claim.
- Learn from the Debtor’s Filings. During the administration of the debtor’s bankruptcy, the debtor will file various schedules that provide information about the debtor and their plans in bankruptcy. One of those filings, the Statement of Financial Affairs, should list all payments and transfers the debtor believes to have been made during the 90-day preference period. If the information regarding your business is improperly or incorrectly detailed, notify the debtor’s counsel of the discrepancy. By correcting the mistake, you may prevent a preference claim entirely or reduce amount of a forthcoming preference demand.
- Take Action. Upon discovery of a debtor’s bankruptcy, take action! Do not wait for a preference claim demand letter, otherwise important information may be irretrievably lost. First, determine the date bankruptcy was filed. Second, investigate whether you received any transfers from the bankrupt company in the 90-day period prior to bankruptcy. Third, if transfers were made keep all correspondence, e-mails, invoices, or records of payment associated with the transfer. Fourth, preserve documents demonstrating your ordinary course of business with the debtor. Those documents may be essential later when defending against preference claims. Fifth, prepare to preserve these documents for at least two years. Finally, don’t ignore the preference demand. It’s unlikely to go away, and if the trustee doesn’t get what they are seeking through their demand, they may file a lawsuit to obtain the asset back.
- Negotiate Preference Claims. The ability to negotiate a preference claim depends on a variety of factors, but professional assistance can help you examine those factors and your likelihood of success inside or outside the courtroom. Hiring an attorney who knows how to respond to demand letters, navigate the law, may help you get the most out of a negotiation.
Martin Pringle bankruptcy attorneys are experienced in assisting creditors navigate the bankruptcy process and maximize potential returns. We can keep you apprised, take action, monitor the bankruptcy, negotiate, and create a favorable outcome when you are faced with a preference demand or lawsuit.