NEED TO KNOW- PREFERENCE IN BANKRUPTCY-HOW CAN THIS BE?
This post is primarily for non bankruptcy attorneys , business owners and anyone else who receives a payment from a person or entity within 90 days of that person or entity filing for
bankruptcy. This article will not examine the complex application of preference claims or defenses, but will provide basics of what to do if you get a call or inquiry from a client, friend or family member that a preference demand or claim has been made against them. The complexities of preference claims , defenses will be the subject of a later "NEED TO KNOW " Post - when I have more time.
Here is how it often goes-You receive a call from a client screaming or talking loudly that she received a demand from a bankruptcy trustee for return of money paid to her company by a customer. She can't understand it because she shipped the product and there were no problems with the product. Exasperated , she says there must be a mistake!
So if you receive one of these calls from your client , family member or friend, tell them that a preference is a bankruptcy code provision ( 11 U.S.C. 547 if you want to seem knowledgeable) designed to capture/ claw back payments made by a debtor shortly before filing for bankruptcy ( within 90 days for payments made to a non insider and 1 year for payments to an insider) which are to pay a debt owed and such payments were made outside the ordinary course of business (between the parties( subjective test) or the industry standards( objective test)) . Tell them there are defenses if the company advanced credit during the 90 days ( product or the like) and were not paid back or if the payments were made in the ordinary course of business . And then if you want to be really honest ( which you should be of course) tell them most preference cases settle but it will cost you to defend and most likely a chunk of cash the amount depending on several factors, including (1) the strength of the defenses; (2) the trustee and attorney on the other side and (3) the presiding judge and his/her views on preference cases, defenses and how they are applied by that judge.
When they start asking more and more questions and ask you how can this be as their company is actually owed money, have had a long term relationship with the debtor and did nothing wrong? You can then either refer it to a bankruptcy attorney or press on. If you press on, tell them that the preference law has nothing to do with fault or bad intent, but is an arbitrary time period which was made up by Congress to stop favored creditors from being paid ahead of others and to even the playing field for those creditors who were not paid back- or something like that. Trust me, that will not make your client feel better or calm him/her down.
Then the client asks you what are the defenses and how can you get me out of this. Tell him that the best defense is if your client provided product within the 90 days and that remained unpaid at the time of the bankruptcy filing. A credit / set off of sort. For example, if your client's company received $100,000 in preferential payments but were unpaid for $90,000 of product provided during that same period, you would be entitled to a credit and an honest trustee ( which most are) will automatically reduce the amount sought to $10,000. This is called the subsequent new value or new value defense( 11 U.S.C. 547(c)(4)) . In some jurisdictions the defense is complicated and much narrower than a straight credit and depends on when the product which remains unpaid was provided. In other jurisdictions, including the 11th Circuit, relatively recent law provides that any unpaid product can be used as a credit against paid preferential payments during the preference period . ( ok- I will cite the 11th circuit case, Kaye v. Blue Bell Creameries,Inc., 899 F.3d 1178 (11th Cir. 2018).
This change broadening the " New Value " defense is a big deal and cheered by creditors and not so much by Trustees/Debtors who make a lot of fees on prosecuting preference claims to bring cash to the general creditors . In a recent case of mine my client had provided " new value " and the claim was reduced up front by over $1,000,000. The analysis would have resulted in much less of a set off without the recently broadened New Value defense.
If there is no new value set off or there is a remaining amount after applying legitimate new value, your client needs to get out its checkbook or at least be ready for some type of payment either to defend the case or settle the case. The most common defense to the preference claim is the clients assertion that the payments which the trustee/debtor contends are preferential were in fact made in the ordinary course of business between the parties or ordinary in accordance with industry standards. What the heck does that mean you may ask? Well, it depends on who you ask. The trustee will say your client was paid to slow in accordance with past practice between the parties or to fast or whatever. What the trustee is really saying that the issue of ordinary course is a question of fact, the law is all over the place, it depends on the judges view and it will cost you a lot to defend. So pony up with a settlement.
The trustee is probably right unless you have a very strong ordinary course situation where the timing of the payments made on account during the preference period are very close to the timing for payments made in the past year or two prior to the bankruptcy 90 day preference period. Almost all preference cases are settled, likely higher than plea bargaining in criminal cases. But the amount of the settlement depends on many factors, including the strength of the ordinary course defense. The closer the timing is to payments made during the preference period from date of invoice to the timing of payments made during a significant period in the past between the parties, the better leverage your client will have in settlement negotiations. For example , if the average payment term was 35 days from date of invoice during the preference period and was 32 days for the 2 year period prior to the preference period, the client has an excellent ordinary course preference defense. There are lots of interesting arguments both sides make as to timing, certain payments which skew the timing due to unusual circumstances which are explainable, but you get the gist of it.
There is also a defense if the payment was made contemporaneously with the delivery of the product or service. Trustees normally weed those out , but I wanted you to know.
In addition to the bankruptcy defenses, there is the age old defense of inability to pay. It is not in the Code, but it is very effective!This can be effective as the Trustee's do not want to chase defendants, they want cash on the barrel, not unlike any case .
Bankruptcy judges generally appreciate the parties settling these matters as well and the trustee does not want to lose to much favor with the judge by beating up on defendants who did nothing wrong (in most cases )other than sell product to the debtor and get paid for the product or service.
A practice pointer for attorneys/law firms --you are not immune. So make sure if you are representing a debtor in financial distress, that you are paid in the ordinary course. I have represented several law firms sued for preferences- it hurts!
I am writing this blog now as there are many large bankruptcies being filed around the Country and the filings will keep coming. So over the next few years you can expect these type of calls from your clients,relatives or friends. Do not expect them to understand or want to understand the equitable principles involved in the arbitrary 90 day period for claw backs.The above is a non legalistic road map to the conversation you could have with a client and general issues involving preferences. I hope it helps you and your client.