What is a Preference in Bankruptcy and Why It Matters to Your Business?
There are perhaps few things more frustrating than when one of your customers files for bankruptcy leaving you with the tab. However, is this really the worst thing that can happen? Unfortunately, it is not. Even though your customer has filed bankruptcy and perhaps even paid you, Section 547(b) of the Bankruptcy Code permits the debtor-in-possession or a trustee to recapture those payments from you. These payments made by a customer right before filing bankruptcy are known as preference payments. Put simply, the customer preferred to pay you rather than someone else. Although it is not always achieved in practice, the policy goal underlying the preference statute is to further the goal of equality of treatment of creditors of the debtor. Accordingly, the Bankruptcy Code authorizes the recapture of these payments for the benefit of the bankruptcy estate.
What are the elements of a preference?
The elements of a preference payment set forth in Section 547(b) of the Bankruptcy Code are as follows:
- The transfer was made to or for the benefit of a creditor (i.e., creditor receives a check from the debtor, goods are returned by the debtor to the creditor or an obligation of the creditor is reduced by the debtor);
- The transfer was made for or on account of an antecedent debt owed by the debtor before the transfer was made (this is merely a payment or transfer made on an old debt, i.e., not a cash on delivery or cash in advance payment);
- The transfer was made while the debtor was insolvent;
- The transfer was made 90 days before the date of the filing of the bankruptcy petition (extended to one year if the transfer was made to an insider); and
- The transfer enables the creditor to receive more than it would have received if the case were a Chapter 7 liquidation. A payment received within 90 days of the bankruptcy filing almost always enables a creditor to receive more than it would have received in a Chapter 7 case. Indeed, the only time this would not be true would be in the unusual case where creditors were receiving 100% on their claims pursuant to a plan of liquidation.
Keep in mind that there is no value judgment linked to a creditor receiving a preferential payment. It is neither wrong of the debtor to make a preferential payment nor wrong of the creditor to accept it. It is almost always better to get paid and deal with efforts by a trustee to recover the payment.
What happens when the customer files bankruptcy and I received a payment?
Typically, a preference action is often preceded by a “demand letter” from the debtor or the trustee. The demand letter sets forth the trustee’s claims and demands payment. More often than not, the trustee is willing to settle the preference action for a reduced amount if the settlement is reached before the lawsuit is filed. As a result, depending on the amount of the payment, when the creditor receives a “preference demand letter,” the creditor should have an experienced bankruptcy attorney review the case to determine whether the creditor has valid defenses. Often times a favorable settlement can be negotiated which will allow the creditor to avoid having to expend large sums of money in litigation.
However, if the parties cannot reach a settlement, the preference action is initiated with a complaint filed with the bankruptcy court. The preference complaint is similar to any other lawsuit with the exception that it is filed in bankruptcy court instead of federal district or state court.
Are there defenses to a preference action?
Yes, there are several affirmative defenses to a preference action. Three of the major affirmative defenses which can be asserted by the creditor/defendant are:
- the new value defense;
- the ordinary course of business defense; and
- the contemporaneous exchange defense.
Each of these affirmative defenses will be discussed in detail in upcoming blog posts so stay tuned!
What is a Small Business Bankruptcy and How It Can Help Your Business?
COVID19 has drastically changed the way we do business. From government shutdowns, reduced business hours, regulations and fewer customers, small businesses have faced an onslaught of hurdles that practically makes it impossible to effectively run a business. What you may not be aware of, however, is that United States Bankruptcy laws may be able to keep your business in business. In this article, we explore how small businesses are treated in bankruptcy as well as additional relief provisions afforded by Congress due to COVID19.
On August 23, 2019, well before COVID19, Congress enacted the Small Business Reorganization Act (“SBRA”). This law took effect on February 19, 2020. It was designed with the intent to help small businesses reorganize their affairs, stay in business and not be unduly burdened by the bankruptcy process. This new law only applies to small businesses or proprietors with less than $2.7 million of debt relief. In March, 2020, in the wake of the pandemic, Congress passed the Coronavirus Air, Relief and Economic Security Act (CARES Act) which increased the debt limits of the SBRA to $7.5 million.
Here is how these new laws help your small business in bankruptcy.
- Debtors – businesses or individuals – can now file for relief if their total debt amounts to a maximum of $7.5 million, with at least 50% of it being commercial debt.
- The bankruptcy court will hold a mandatory status conference within 60 days to “further the expeditious and economical resolution” of the case.
- The process of filing bankruptcy when you own a business will be much faster. The deadline has been revised to 90 days from 120 days.
- SBRA debtors are not mandated to pay the obligatory quarterly US Trustee’s Fees which are significant in a traditional Chapter 11 Bankruptcy case.
- Debtors will be able to stretch out the duration of administrative expense claims over the entire term of the plan.
- A plan of reorganization can only be filed by the debtor, effectively eliminating the risk of creditors filing competing plans.
- The plan of reorganization filed by the debtor does not require voting by creditors meaning that there is a greater chance of confirmation.
- Unless the bankruptcy court states otherwise, debtors do not have to provide a disclosure statement.
- Creditors’ Committees will not be appointed under the new SBRA standards thereby reducing significantly administrative costs and their counsel fees.
- A business owner can still keep their equity interest in the company even though unsecured creditors won’t receive full payment.
- A bankruptcy trustee will be appointed to assist the company in restructuring its debts and assisting the debtor to formulate a consensual plan and by monitoring distributions in accordance with the terms of the plan
- A debtor’s plan can modify a mortgage against a principal residence (unlike a typical non-SBRA Chapter 11 plan) provided that the mortgage loan was not used primarily to acquire the residence.
Perhaps most importantly, the bankruptcy process buys the small business time – which in these uncertain times is absolutely necessary. With governmental relief for COVID19 diminishing, a small business bankruptcy may provide the much-needed relief and time until the economy is back on track.