After I send back the preferential payment, how do I get paid for the original goods/services?

To obtain any kind of recovery on a debt from a debtor who has filed for bankruptcy protection, you must file a document called a “Proof of Claim,” which summarizes the amount of debt and its priority. Often, your debt will be listed in the bankruptcy filing, and you will be sent a Proof of Claim by the Bankruptcy Court. You don’t necessarily need a lawyer to fill out the Proof of Claim form, but you probably should consult an attorney if you receive a preference demand letter. Attach to the Proof of Claim a copy of the invoice or contract that forms the basis of your claim, or a summary of the elements that make up the claim. The Proof of Claim is then filed with the Court, or sent to a claims agent if the case is a big, publicly traded company like Circuit City or LandAmerica.

After I file my Proof of Claim, when will I get paid, and how much will I get paid?

When you get paid, and how much you get paid, depends on several factors, including which chapter the debtor has filed (7, 11 or 13), and how much there is available to pay creditors. In a chapter 7, for example, a trustee sells all of the assets of the bankrupt company, and then distributes what is left after costs of liquidation to the creditors. If there are a lot of things to be sold by the trustee, it will take a long time before funds are distributed to creditors. In a chapter 13, distributions to creditors generally happen more quickly. In large, Chapter 11 cases, the Chapter 11 Plan must first be confirmed &endash; a process that can take many months.

Another situation that might reduce the amount of repayment is to provide “subsequent new value” to the debtor. It is like a set off. If you receive a preference demand that is not subject to any defenses, but after (subsequent to) the payment they seek back, your company sent more goods or provided more services to the debtor, and has not yet been paid for those subsequent goods/services, then you can reduce the preference liability exposure by the amount of subsequent unpaid goods/services.

Although this does reduce the preference liability, companies don’t like to be in this position, because they are not getting paid full value for any of the goods/services provided.

One final tactic may be to demand alternative sources of recovery for you, such as co-borrowers, or guarantors of the debt. A good creditors’ rights attorney can properly identify which of these strategies may be useful in your particular situation.

Although the Bankruptcy Code gives the power to recover these preferential transfers, your business may have certain defenses to defeat, or at least lessen, your exposure.

These defenses include:
• The debtor was not insolvent when it paid you;
• payments made in the ordinary course of business;
• contemporaneous exchange for new value;
• payments made outside of the 90 day preference period (so long as you are not an insider);
• payments made via C.O.D.

Whether a defense applies is a very fact-specific determination made after detailed review of the account information and history between the debtor and creditor. Unfortunately, it is becoming common for Trustees or debtors in possession to sue everyone receiving payment 90 days prior to the bankruptcy filing, and to sort out the merits of each claim later. In practicality, this often results in unknowing creditors sending back non-preferential payments or creditors deciding it is too much trouble to defend a preference claim and not asserting valid defenses.

This area of law is not only very fact-specific, but very technical and procedural. We strongly advise consulting a bankruptcy attorney to assist in minimizing your risk and maximizing your recovery.

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.