January 31, 2019
You are contacted by your client who has received a letter from a bankruptcy Trustee. The letter demands the return of payments received from the bankrupt party during a specified time period that likely occurred months, or years, previously. With small exception, your client is likely frustrated and will deem the Trustee’s demand as patently unfair. This is a common scene replayed countless times by clients involved with an alleged claim for preferential transfers under 11 USC § 547 of the Bankruptcy Code. Your client is now being pursued for a preference.
The Bankruptcy Code gives the Trustee (or Debtor in Possession) the ability to avoid certain transfers made by the debtor to creditors within the 90 days prior to filing for bankruptcy (potentially a year if the recipient is an insider). The general policy regarding preference actions is that similarly situated creditors should be treated equally. Conceptually, the term arises because without such a provision in the code, a debtor could “prefer” to pay certain creditors in the months leading to a bankruptcy filing, thereby unfairly tipping the scales. The preference action allows the Trustee to claw back the preference funds and pay creditors in equal pro-rata measure.
There are a limited number of defenses available to a preference action. The available defenses first require an understanding of the basic elements of the preference itself. The Code defines a preference as:
1. A transfer of an interest of the debtor;
2. to or for the benefit of a creditor;
3. for or on account of an antecedent debt;
4. made while the debtor was insolvent;
5. made within 90 days (or one year if an insider);
6. the transfer resulted in the creditor receiving a greater amount than it otherwise would have in a hypothetical chapter 7 distribution.
The Trustee must prove each of the required elements in order to prevail.
Even if the Trustee can prove these elements, there are a handful of defenses that are often cited in response to the action. These defenses are premised by the concept that creditors should continue to conduct business with financially troubled entities because the alternative would only hasten a potential bankruptcy filing. It is the defendant’s burden to establish these defenses:
· Contemporaneous Exchange for New Value – 11 USC §547(c)(1) – prevents the Trustee from recovery when the transfer was intended to be, and was in fact, a substantially contemporaneous exchange for new value given to the debtor. This protects creditors when contemporaneous new value was granted in exchange for the transfer such that the bankruptcy estate was not effectively diminished. A common example would be COD transactions.
· Subsequent New Value – 11 USC §547(c)(4) – prevents Trustee from recovery when creditor can show subsequent new value for benefit of the bankruptcy estate.
· Ordinary Course – 11 USC § 547(c)(2) – prevents the Trustee from recovery when creditor can establish that transfer was in payment of a debt incurred in the ordinary course of business or financial affairs of both parties or was made according to ordinary business terms. While seemingly simple, there are a number of issues that can arise that can complicate this analysis.
Regardless of possible defenses, it is important that your client not ignore the Trustee. Timelines can be relatively short depending in some circumstances. A prompt response, an outline of available defenses, and in some cases a cash offer, can help quickly and efficiently help resolve a preference matter. While any discussion with a client about a preference action is difficult, a working knowledge of the elements and defenses will help determine the next step.
The attorneys at Keller & Almassian, PLC can help explain this process. Please contact us with any questions.