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Word on the street is that Tarheel Dominion Company, a pretty large customer of yours, is in a cash crunch. You are, however, relieved when you receive timely payment of $100,000 for services you rendered to Tarheel Dominion, and the check clears.

Two months later, you hear that Tarheel Dominion has filed for Chapter 11 bankruptcy protection. While you are upset to lose a long-time customer, you are pleased that your latest payment was received before the filing and you assume that the bankruptcy won’t affect you significantly or at all.

But then you receive a letter demanding that you repay the $100,000 because it was a “preferential transfer” under the Bankruptcy Code.

What is going on? You have recieved a “preference demand letter.” In our next few blog entries, we will discuss in detail some issues relating to bankruptcy that are of general interest to businesses, including what preferences are, the defenses to a preference claim, how to avoid claims of preferential transfers and how to file a proof of claim to get paid from the bankrupt customer.

What is a preference or a preferential payment or transfer?

Bankruptcy Code §547 defines a preference as:

• Payment on an antecedent (as opposed to current) debt;

• Made while the debtor was insolvent;

• To a non-insider creditor (e.g., a payment made to a creditor who is not an owner of the bankrupt customer);

• Within 90 days of the filing of the bankruptcy;

• 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.

The policy behind bankruptcy preferences is ensure that all similarly situated creditors (e.g., all unsecured creditors) are treated equally in the bankruptcy case, and one is not “preferred” or favored over all other creditors. If you got to keep the $100,000 you received, some other creditor may end up with nothing. The preference laws also prevent an individual or company that knows it will file bankruptcy, from paying only those creditors it wants to favor right before filing.

To prevent this, creditors who receive “pre-petition” payments, within 90 days of the bankruptcy filing, may have to repay of all the payments/transfers they received. These payments are then re-allocated more equitably among all creditors. In short, the preference statutes are simply an attempt to achieve equity between creditors based on the timing and nature of payments.

Tags: bankruptcy, Chapter 11, creditor, debtor, preference, preference demand letter, preference payment, preferential payment, preferential transfer, proof of claim, Section 547

This entry was posted on Wednesday, May 20th, 2009 at 9:43 am and is filed under Bankruptcy law, business law, Consumer Law, small business. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.