Greenbaum, Rowe, Smith & Davis LLP

In This Issue:

Bankruptcy & Creditors' Rights Law Alert

December 2008

ADDING INSULT TO INJURY: DEFENDING PREFERENCE CLAIMS

If you sell goods or services on credit there is a good chance that one or more of your customers/clients will file for bankruptcy during the coming year, if some have not already done so. If you did not arrange for collateral to secure the debt, you will be considered an unsecured creditor in a bankruptcy proceeding and the typical distribution to unsecured creditors is nominal; pennies on the dollar. And if that loss is not enough, you will most likely receive a letter months later from the bankruptcy trustee or the creditors committee asking that you return payments received from the debtor during the 90-day period preceding the bankruptcy filing. Such payments are called “preferences.” If the trustee or committee is successful in pressing a preference claim, your original loss will increase, sometimes dramatically. That is the insult to the injury.

Rather than immediately paying the amount demanded or some percentage of the same in settlement, you would be better served by having us analyze the claim and determine if one or more available defenses would reduce or eliminate the preference claim entirely. The most common defenses are payments received in the ordinary course of business and when “new value” is given in exchange for the payment, such as when further goods or services are sold on credit to the debtor subsequent to receipt of the offending payment.

Even in situations where statutory defenses are not immediately apparent, the fact thatyou have retained knowledgeable counsel to contest the preference claim can often result in a greater discounting of the amount in issue in settlement of the matter. Like any other claim or demand for payment, if the party on whom the demand is made does not willingly pay, litigation by the trustee or creditors committee would be the next step in the collection process. In appropriate cases, the litigation will provide the contesting party with an opportunity to discover additional facts and circumstances which will support a defense to the preference claim. Moreover, avoiding the cost of litigation is always a practical consideration for both parties when discussing a discounted payoff in settlement of a claim. It may also be relevant to determine (through review of the court docket in an underlying case) if the counsel retained by the trustee or creditors’ committee to pursue preference recoveries is working at an hourly rate or for a contingent fee, since in the latter instance, counsel may recommend a reasonable settlement as early as possible in the process in order to avoid spending significant additional time without the prospect of receiving meaningful additional compensation for such efforts.

Preference demands are routinely asserted by the holders of such claims based solely on a cursory review of a debtor's books and records without a proper analysis of the underlying claim. We have seen demands for the return of checks written by debtors but never actually sent to the payee, as well as checks for COD or prepayments, with no liability existing for the former (unsent checks), since no transfer of property (funds) of the debtor actually occurred, or for the latter (COD checks or prepayments), since a payment must be on account of a pre-existing debt in order to be preferential and thus recoverable by a debtor or its trustee.

Other statutory defenses may exist to a "naked" preference demand. Some of the potential defenses are more easily discoverable than others, but the bottom line is that a recipient of a preference demand letter should for the amount demanded to be returned to the bankruptcy estate. The recipient will be better served by having someone with intimate familiarity of the relevant statute (11 U.S.C. § 547) and case law carefully analyze all relevant facts in an effort to thereafter reduce, if not eliminate, any potential exposure for the transfers in question.

The Bankruptcy and Creditors’ Rights Group at this firm is staffed with attorneys who each possess twenty or more years of experience working on preference matters, from both the plaintiff's and defendant's sides. As a result, we are available to assist you in analyzing your actual exposure in response to a preference demand, and to then negotiate a reasonable settlement of any demand asserted against you or your company for the return of allegedly preferential payments. Keep in mind that the Bankruptcy Code is a federal statute, which means that the provisions apply regardless of where a bankruptcy case may have been filed. Accordingly, we can be of assistance in resolving demands that are made in cases venued in New York, New Jersey, Pennsylvania and Delaware, or anywhere in the U.S., for that matter.

For more information contact:

David L. Bruck, Chair, Bankruptcy & Reorganization Practice Group

Dbruck@greenbaumlaw.com

Direct Dial: 732-476-2440

Lawrence P. Maher, Partner, Banking, Business Financing & Creditors’ Rights Practice Group

Lmaher@greenbaumlaw.com

Direct Dial: 732-476-2570

Author of this Alert:

Robert Underhill, Counsel, Litigation Department

Runderhill@greenbaumlaw.com

Direct Dial: 732-476-2386