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

Avoidance of Preferential Transfers: Is this for real?!

Written by: Christopher M. Dube

3/30/2020

When a customer becomes a debtor in bankruptcy, your first act should be to take all necessary steps to avoid violating the automatic stay imposed by the United States Bankruptcy Code.  The automatic stay is interpreted broadly, but, in short, you and anyone acting on your behalf must suspend all collection activity, including lawsuits, collection calls, billing, etc., unless and until the Bankruptcy Court orders otherwise. 

You will then want to go back and examine historical transactions to determine the extent of your exposure to risk of having to return payments to the customer’s bankruptcy estate.  If you have taken steps like those set forth below, then (1) the possibility that you may be required to return payments will not be a complete surprise and (2) you will already have a good sense of your exposure.

Is this letter for real?

As those in the unenviable position of having received a demand letter from a bankruptcy trustee have found, such letters are very real.  In fact, the United States Bankruptcy Code empowers a bankruptcy trustee or estate to compel recipients of certain payments made by the debtor during the 90-day period immediately preceding the commencement of the case to disgorge those payments.  This power can be enforced even when a recipient is owed money from the debtor.

Do I really have to pay it all back?

Not necessarily.  The Code provides certain defenses, summarized below. 

Insolvency.  Insolvency is generally not a contested issue (because most bankruptcy debtors were struggling long before the 90-day “preference period”).  However, it is important to note that a prerequisite for recovery of a “preferential payment” is that the debtor was insolvent at the time a payment was made or was rendered insolvent by the transfer.  Insolvency is presumed under the Bankruptcy Code, but it is a rebuttable presumption.  If there is any question whether a debtor was insolvent at any point during the 90-day period, then you and counsel should consider retaining an insolvency expert to provide an analysis. 

Ordinary Course Defense.  Payments made within the ordinary course of business established between a debtor and the recipient are not recoverable.  The meaning of “ordinary course” in this context is not as obvious or intuitive as it may appear.  The meaning of “ordinary course” and application of this defense have been widely litigated.  This defense is somewhat subjective and inherently fact intensive, taking into account factors such as timing of payment, manner of payment (e.g., grouping of invoices and method of payment), changes in quantities, changes in terms and conditions, and communications between the parties to the transaction.  Analysis supporting an ordinary course defense requires the comparison of the transactions within the 90-day period with the transactions prior to the preference period (typically going back 18-24 months prior to the case).

Subsequent New Value Defense.  A typical “subsequent new value” defense involves a retainer, deposit, or cash payment made in advance of shipment.  A vendor is entitled to credit against preference exposure the value of goods (for which the vendor was not paid) delivered following receipt of the otherwise avoidable transfer.  You will need to establish timing of delivery (e.g., bills of lading), because the credit is for goods actually delivered after a payment was received and before the commencement of the case.  The value of the goods subsequently delivered is sometimes also subject to dispute.

Contemporaneous Exchange Defense.  A typical contemporaneous exchange transaction is cash on delivery (COD).  The transaction must be substantially contemporaneous and must be intended by the parties to be a contemporaneous exchange.  Since intent is one element that must be proven, it is preferable that it be memorialized in an agreement, email, or other written record.  Payment by wire transfer helps support a contemporaneous exchange defense if tendered promptly.

In summary, letters demanding recovery of payments made during the 90-day period immediately preceding a bankruptcy case require immediate attention.  Facts must be determined, appropriate supporting documentation assembled, applicability and strength of potential defenses analyzed, and defenses timely asserted.  It may be necessary to assert a combination of defenses.  You should consult counsel promptly upon receipt of such a demand letter.

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.