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Your Legal Corner - Client Alert Blog

Why You Need to Know About Bankruptcy Preference Laws

Written By: Melissa C. Marsh, Esq., California Attorney, June 2009 Add to Favorites
Is your business having trouble trying to collect on its accounts? Most, if not all, are as more and more individuals and businesses are facing the very real possibility of declaring bankruptcy. This post seeks to explain what happens if one of your clients, or customers, remits a payment to you and shortly thereafter declares bankruptcy.

if you, or your business, receives a payment from a client or customer that files bankruptcy within 90 days of making that payment, the bankruptcy court might demand that you pay the money back. If you are paid 91 days before, you are safe, and no one should come calling for the return of that payment. However, if you were paid within that 90 day period, then the bankruptcy court trustee will likely label the payment a preference and demand its return to the bankruptcy court.

Bankruptcy Code §547 defines a preference as a payment on an antecedent (prior existing) unsecured debt made while the debtor was insolvent within 90 days of filing for bankruptcy, that allows the creditor to receive more than it would have received had the creditor not been paid and presented a claim to the bankruptcy court. Needless to say in a Chapter 7 Liquidation Bankruptcy most creditors are paid $0.

If your business has received such a payment, and received a preference complaint, your business can answer the complaint by asserting one of the following common defenses: (1) it was a contemporaneous exchange; (2) payment was made in the ordinary course of business; (3) the debt was a secured debt; and (4) the "new value" defense – the business extended additional credit which has gone unpaid.

The bankruptcy code also permits the bankruptcy trustee to recover payments made by the debtor to insiders (relatives, corporate officers or directors, related business entities, etc…) up to one year prior to the filing of a bankruptcy. This provision in the bankruptcy code seeks to prevent the debtor from paying relatives, friends, and himself through related business entities at the expense of regular creditors.

If your company receives a preference complaint from a bankruptcy court, or a letter from the debtor's estate, don't ignore it. You should respond to the letter, or complaint, in a timely fashion with one or more of the defenses mentioned above.

Since there is a real possibility that your company will find itself on the receiving end of a bankruptcy preference petition, or letter, all businesses should consider implementing strategies to reduce the risk of being served with a "preference lawsuit." Businesses today should consider offering a discount to new clients and new customers who pay in advance, or C.O.D. For existing customers, businesses would be well advised to make sure their payment history and practice doesn't change – if a customer always pays about 30 days after invoice, be wary of accepting a payment just 10 days after invoice because if that client files for bankruptcy within the next 90 days, the court will say the transfer was NOT in the ordinary course of business since the debtor typically paid 30 days after invoice. Sometimes speaking with your customers and advising them of the law can also be helpful.

In these hard economic times, it is also extremely important to keep detailed organized records of all of your purchase orders, invoices, contracts, cancelled checks, and bank statements. These records will be essential to asserting any one of the affirmative defenses applicable to a preference claim.


Tags: bankruptcy preference, defenses to a bankruptcy preference petition, preference letter
Posted In: Business Law Bulletin  Corporate Client Bulletin 


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Disclaimer: The information presented on this web site was prepared by Melissa C. Marsh for general informational purposes only and does not constitute legal advice. The information provided in my articles and alerts should not be relied upon, or used as a substitute for professional legal advice from an attorney you retain to advise or represent you. Your use of this Internet site does not create an attorney- client relationship. Transmission of this article is not intended to create, and receipt of it does not constitute, an attorney-client relationship. All uses of the contents of this site, other than personal uses, are prohibited. You may print or email a copy of any information posted on this web site for your own personal, non-commercial, use, but you may not publish any of the articles or posts on this web site without the Express Written Permission of Melissa C. Marsh.


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Located in Los Angeles, California, the Law Office of Melissa C. Marsh handles business law and corporation law matters as a lawyer for clients throughout Los Angeles including Burbank, Sherman Oaks, Studio City, Valley Village, North Hollywood, Woodland Hills, Hollywood, West LA as well as Riverside County, San Fernando, Ventura County, and Santa Clarita. Attorney Melissa C. Marsh has considerable experience handling business matters both nationally and internationally. We routinely assist our clients with incorporation, forming a California corporation, forming a California llc, partnership, annual minutes, shareholder meetings, director meetings, getting a taxpayer ID number (EIN), buying a business, selling a business, commercial lease review, employee disputes, independent contractors, construction, and personal matters such as preparing a will, living trust, power of attorney, health care directive, and more.