Back
Back
Back
Back
Back
Back
Back
Back
Back
Back
Back
Back
Back
Back
Back
Back
Back
Back

A 'preference'™ you'd prefer to avoid: Steps to prevent being caught up in a bankruptcy court 'preference'™ action

Written by: Joseph A Foster

Published in the NH Business Review, Friday, December 5, 2008 (http://nhbr.com/apps/pbcs.dll/article?AID=/20081205/INDUSTRY04/812039908&SearchID=73338457347184)

It’s a fact of business: Some customers will pay slowly and sporadically, promise to catch up, convince you to ship more and then, sadly, file for bankruptcy.

Having written off the debt and mentally moved on, two years later you may receive a letter from the bankruptcy trustee demanding you return those all-too-small sporadic payments, along with a threat that if you fail to do so he will sue you in a courthouse that is often hundreds, if not thousands, of miles away. He will not care that you are still owed amounts by the bankrupt customer. The suit can be filed even if you are still owed more than the amount you were paid and he seeks to recover.

This type of claim by the trustee is called a "preference" action. The intent of the law is to prohibit insolvent companies from playing favorites or preferring a particular vendor. Preference claims force the preferred vendor to return the payment so that all creditors can enjoy equality of treatment. By recovering funds from the preferred vendors, the discriminated vendors can ultimately receive more, or so the theory goes.

But except in the rarest of circumstances the preference law seems only to bring one thing: insult to injury.

A preference claim is unfortunately very simple to bring and very easy to prove. All the trustee needs to prove is that a payment was made:

  • Within 90 days of the bankruptcy filing
  • For an "antecedent" debt
  • When the customer was insolvent
  • As a result, you received more than you otherwise would in the bankruptcy.

These elements are easy to establish. The company is presumed to be insolvent within 90 days, and to disprove that is obviously costly. It would require appraisals and experts to disprove insolvency, and except in the largest of cases simply does not make economic sense to challenge the presumption.

Therefore, the burden is on you to prove one of several enumerated defenses available. That means hiring legal counsel to defend you in a bankruptcy court that may be anywhere in the United States.

Know your rights

Defenses exist under the code, two of which commonly are asserted and often work. First, if payment was made in the "ordinary course" of business, it is not recoverable. To show a payment was made in the "ordinary course," you must demonstrate it was made consistent with industry practice or consistent with your past dealings with that customer. If the customer always paid slow but with regularity, the defense may work.

There also is the so-called "new value" defense. If you shipped or provided services after payment and the new invoice remains outstanding, the new invoice can be offset against the payment the trustee is seeking to recover. This "new value" defense encourages businesses to continue to trade with a troubled customer.

While it’s helpful to know your rights in a preference action, it is always better to avoid the action altogether.

First, when payment is slow, try to convert the customer to payment in advance or C.O.D., which is not recoverable because they are not made on account of an antecedent debt.

Less obvious options also are available. If an account is out-of-terms (i.e. payment now definitely would be outside the "ordinary course"), you may demand they arrange payment from a third party, such as an affiliate, parent, subsidiary or even a lender if properly documented.

A third-party payment is unavoidable because the bankrupt customer’s assets are not used to make the payment.

A similar approach is to seek a third-party guarantee by a solvent entity. If a preferential payment is recovered by the trustee, you will be able to pursue the guarantor for payment. If an outright guaranty is rejected, ask for one more limited - a guaranty against preference recoveries only. The guarantor may feel the extent of potential liability is acceptable when it is limited to the preference period.

For small commercial accounts, consider taking less than $5,000 in settlement. Amendments adopted in 2005 provide an absolute defense if the aggregate payment received in the preference period is less than $5,000. If the debt is near $5,000, accept $4,999 and waive the balance to induce payment.

Other techniques exist, such as taking security, transferring the payment or assigning payments to third parties. If all else fails, still take the payment! Thoughtful planning can reduce the risk of loss in a preference action. But accepting payment is better than not receiving any payment at all.

Joe Foster is Chairman of the Bankruptcy Practice Group at McLane, Graf, Raulerson & Middleton, Professional Association. He can be reached at (603) 628-1175 or at [email protected]. The McLane Law Firm is the largest full-service law firm in the State of New Hampshire, with offices in Concord, Manchester and Portsmouth, as well as Woburn, Massachusetts.

Integrity and trust

At McLane Middleton we establish and maintain long-standing relationships with our clients to help us better achieve their unique goals over time. This approach to building trust requires that our esteemed lawyers and professionals use their broad, in-depth knowledge and work together with integrity to ascertain sound resolutions to legal matters for their clients.

Strength in numbers

McLane Middleton is made up of more than 105 attorneys who represent a broad range of clients throughout the region, delivering customized solutions. As a firm we are recognized as having the highest legal ability rating. The firm is rated Preeminent by Martindale Hubbell and is recognized as one of the nation's leading law firms in Chambers USA. Our attorneys are distinguished leaders in their respective practice areas.

Meet Our People

Commitment and collaboration

McLane Middleton's versatile group of attorneys and paralegals become trusted authorities on each case through collaboration. We work with our clients to learn their individual needs first and foremost and, together, we develop comprehensive solutions to their specific legal matters. This approach helps us exceed our clients' expectations efficiently and effectively, client by client, case by case.

Practice Areas

A history of excellence

McLane Middleton was established in 1919 in New Hampshire, and has five offices across two states. However, deep historical roots don't allow you to become innate. Our firm is organized, technological, and knowledgeable. Our history means we are recognized. But our reputation is built on the highest quality of service and experience in very specific areas of law.

The Firm

Intelligence paired with action

Our team continuously seeks opportunities to enhance their professional development and put key learnings to action. The pursuit of further insight guides us to volunteer service opportunities, speaking engagements, and teaching roles. Our lawyers are sought after thought leaders across their industries, and recipients of leadership awards throughout the region.