In slow economic times, more and more peoples’ lives and businesses are impacted by the bankruptcy proceedings of others. When this happens, one of the more surprising and frustrating bankruptcy code provisions (11 U.S.C. § 547), could require you to return payments you received from the bankruptcy debtor to the bankruptcy estate. This provision is often referred to as the “preference provision” and indicates that if you received a payment on an old debt within the ninety (90) days before the bankruptcy filing or within one year before the filing if the payment benefited an insider (the preference period); or you were granted a security interest for an old debt within the preference period — you may be required to return that payment. The preference provision is designed to prevent a bankruptcy debtor from preferring some unsecured or under secured creditors over others in the days before filing for bankruptcy protection. However, it often seems unfair to the creditor who was patient with the debtor, finally received payment, and now has to return that payment.
The bad news will often arrive in the form of a demand letter from bankruptcy counsel. If the bankruptcy proceeding is in another state, the cost of defending the preference claim may preclude you from hiring counsel in that state to fight the demand. Do not ignore the letter, and do not immediately give up. The preference provision also contains defenses to alleged preference claims such as payments made in the ordinary course of dealings between the parties using ordinary business terms and contemporaneous exchanges of new value. If the amount of the payment in dispute is sufficient, it may be worthwhile to have your local attorney examine the billing and the payment history involved to determine your next course of action. You may be able to defend the preference claim or negotiate a reduction in the demand. If the debtor signed a credit application and its principals signed a guaranty, it is important to evaluate the value of enforcing the agreement – especially if you are required to return any payments to the bankruptcy estate. You may be able to locally file an action to enforce the guaranty.
If you receive payments from a slow paying debtor, it is worth considering whether you can proactively apply the payment in a way to reduce your risk of a successful preference claim against you. You may also want to deposit the funds — but not expend them — before the ninety (90) day preference period to avoid having to coming up with funds at an inopportune time.
No company or person likes the idea of returning money to a past due debtor, but after you vent your frustrations, take time to discuss the matter with counsel so you can appropriately examine your options and make an economically wise decision.
Phillip Lingafelt is shareholder at Glenn, Feldmann, Darby & Goodlatte specializing in business and creditor’s rights. Visit www.gfdg.com to learn more.