What is a Bankruptcy Preference?
Given that it seems like almost every company is a possible bankruptcy debtor these days, it is important to recognize that money paid by a company that ends up in bankruptcy might be subject to disgorgement. In other words, if you are the recipient of such a payment, you might have to give the money (or part of the money) back.
A preference, or preferential transfer, as it is sometimes called, is the Bankruptcy Code’s way of implementing the public policy which says that it is not fair for one creditor to get paid just before a bankruptcy is filed, while another similarly situated creditor might get nothing. Therefore, the drafters of the Bankruptcy Code chose 90 days as the magic figure. If you are paid 91 days before a bankruptcy filing of your payor, then the payment is safe from attack as a preference and you can keep it. If, however, a payment is made 89 days before the bankruptcy, then the payment may be at risk. If you are considered an insider of the debtor, the time period is one year instead of 90 days.
The other important thing to remember is that it is not just payments of money, but any transfer of the debtor’s interest in property which can be deemed a preference. So, for example, a lien granted within 90 days might be a preference. However, not all transfers made within 90 days of a bankruptcy filing are considered preferences. First, the transfer must be made to or for the benefit of a creditor. Second, the transfer must be on account of an antecedent debt. Thus, for example, an attorney who receives a retainer in advance of performing legal services is not the recipient of a preference (the retainer might be attacked as a fraudulent transfer, but that is beyond the scope of this post).
Third, the transfer must be made when the transferor is insolvent. And finally, the transfer must result in the recipient receiving more than it would have received had the transfer not been made and the debtor was liquidated under Chapter 7. Therefore, if the debtor’s Chapter 7 estate would have paid the creditor in full even absent the transfer, there is no preference.
Once a transfer is labeled a preference, there are a number of defenses. The three most prominent are the so called ordinary course of business defense, the contemporaneous exchange of value defense, and the new value defense. These defenses are very fact specific. Although they cover many situations which arise in business, there are still many situations where no defense is available, or where the cost of a defense would be very high. It is for these reasons and others that most preference lawsuits are resolved by some form of settlement. A future blog post will discuss these defenses in greater detail.
________________________________________
For more information, please contact…
