What if, immediately after a customer pays you for a service you provided, the customer files for bankruptcy relief? You might consider yourself fortunate for not being one of the customer’s other creditors, who might have to wait years before they recover possibly pennies on the dollar. But before you celebrate, take note: the bankruptcy estate could demand that you repay the money that the customer paid, even if there was no dispute concerning the quality of your services.
Why should you have to return any money? Subject to certain exceptions, a bankruptcy trustee may seek to “avoid,” or recover, so-called “preferential transfers” if the debtor made payment to a creditor:
• on account of a debt owed by the debtor before such transfer was made (such as a payment made on credit);
• on or within 90 days before the filing of the bankruptcy;
• while the debtor was insolvent (which is presumed during that 90-day period); and
• enabling the creditor to receive more than the creditor would receive if the bankruptcy case were a liquidation, and if the payment had not otherwise been made.
The rationale behind a preference action is that a creditor should not be “preferred” over other creditors; by bringing into the bankruptcy estate the monies paid to preferred creditors, the funds can be redistributed to all creditors. This might sound fair, especially if a “preferred” creditor was paid ahead of other creditors only because it threatened the debtor’s business or harassed its employees with aggressive collection tactics. But not all creditors fit this mold. For example, a creditor may get paid quickly because it offers a discount for early payment, or is the only remaining supplier willing to sell to the debtor.
Either way, a preference lawsuit could spell disaster for a business if it must return a large preference payment.
Watch for my next article, in which I will discuss strategies to prevent, or favorably settle, a preference lawsuit.
Doug Goldstein, Attorney at Law 