Elements: A preference is a transfer of property of a bankruptcy debtor that (1) was to or for the benefit of a creditor; (2) was on account of an antecedent debt; (3) was made while the debtor was insolvent; (4) was made within 90 days of the filing of the bankruptcy petition; and (5) allowed the creditor to receive more than the creditor would receive if the payment had not been made but the creditor receives what it would receive in a liquidation of the debtor. These elements are almost always (but not absolutely always) met, but there are several defenses available: subsequent new value, ordinary course of business (either between the parties or in the industry), contemporaneous exchange for new value, and others.
Important consideration!: The most important rule to remember is to never, ever pay a preference demand without first performing a detailed analysis of the defenses. The application of each defense is highly technical, and the interplay of the defenses is complicated. This analysis needs to be done by bankruptcy counsel. Bankruptcy debtors or trustees, when making demand for payment of a preference, frequently offer a discount of around 20% to settle. Never accept this offer. These claims can often be resolved for no payment or for a payment under 10% of the demand amount, but the analysis and outcome of each situation is highly fact specific.
Timing of the lawsuit: A lawsuit to recover a preference claim can be brought as late as two years after the bankruptcy filing, and even possibly as late as three years if a trustee is appointed within the two years.
Retention of documents: Upon learning of a customer’s bankruptcy, immediately move to protect the documents needed to present the preference defenses: invoices, remittance advices, bills of lading, proofs of delivery, correspondence, and emails for one to two years before the bankruptcy filing. Failure to preserve electronic communications and other evidence could cause the court to make an adverse presumption regarding their contents, which might hamper or preclude the ordinary course of business or other defenses.
Timing of payments: For purposes of determining whether a payment is a preference, a transfer in the form of a check is made when the check is paid by the customer’s bank, not when the check is received. Thus, a check may be received by a creditor outside the 90-day period but be paid by the debtor’s bank within the 90-day period, and would thus be potentially recoverable as a preference. However, for the purpose of applying the various defenses to the preference claim, the relevant date is when the creditor received the payment.
Defenses: If a payment meets the five criteria set out above for determining whether it is a preference, then the creditor looks to see if one of several defenses will allow the creditor to avoid liability for the preference:
Follow the link to read more of “Bankruptcy Law Update: Preferences and Selected Bankruptcy Issues“, authored by David Grogan, partner at Shumaker, Loop & Kendrick, LLP.