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Defending Preference Actions: Understanding Your Rights as a Creditor




by:
Lacey E. Rochester
Liskow & Lewis A Professional Law Corporation - New Orleans Office

 
July 21, 2014

Previously published on July 14, 2014

There is nothing more frustrating to a creditor than finally getting paid for goods or services, only to have a customer file for bankruptcy protection and, as a result, ending up on the receiving end of a bankruptcy preference action.

In an instant, your right to be compensated for your services or goods seems trampled by a bedrock principle in bankruptcy law—securing equality of treatment of creditors of the debtor. To that end, the Bankruptcy Code allows a debtor in possession or bankruptcy trustee to claw back, or “avoid,” a subset of pre-bankruptcy transfers made by a debtor to creditors within 90 days prior to the commencement of a bankruptcy case. These avoidable transfers are called “preferences” because a debtor is deemed to have preferred one creditor over another. Preferences are disfavored in bankruptcy because they deplete or diminish the estate available for distribution to all creditors when a bankruptcy case is commenced.

The elements of a preference are found in Section 547(b) of the Bankruptcy Code. Generally, a transfer (that is, payment) of money by a debtor is an avoidable preference when made to or for the benefit of the recipient creditor and for or on account of an antecedent debt owed by the debtor to that creditor before such transfer was made. Fortunately, the Bankruptcy Code provides affirmative defenses which may be available to aid an aggrieved creditor in defending against a preference action. In preference scenarios frequently encountered by the oil and gas service industry, two commonly employed creditor strategies involve the “ordinary course” and “new value” defenses.

The ordinary course defense provides that an otherwise avoidable transfer is not subject to avoidance to the extent that such transfer was in payment of a debt that the debtor incurred in the ordinary course of its and the creditor’s business or financial affairs and such transfer was (A) made in the ordinary course of business or financial affairs of the debtor and the creditor, or (B) made according to ordinary business terms. The creditor has the burden to establish that the challenged preference-period transfer falls within the normal pattern of payments by the debtor to the creditor during the pre-preference period. Thus a bankruptcy court must engage in an intense factual analysis of the specific payment terms between the creditor and its customer-turned-debtor to identify any unusual collection activity or actions that provided the creditor with an advantage over other creditors in light of the debtor's deteriorating financial condition.

But the court’s “ordinary course” inquiry does not stop there. Even if the creditor’s payment terms were in fact irregular with this particular customer, the creditor may defeat a preference action if he can establish that the transfers were made according to ordinary business terms as reflected by similar transactions in the relevant industry.

The new value defense allows a creditor to defeat a preference action if the creditor can establish that contemporaneous with or subsequent to receiving the alleged preference payment, the creditor provided the debtor with new assets having a tangible value. Per the Bankruptcy Code, “new value” means money or money's worth in goods, services, new credit, or the creditor’s release to or for the benefit of the debtor of property, including proceeds of such property, in which the creditor previously had a security interest.

“New value” provided subsequent to the alleged preferential payment must have been provided by the creditor on an unsecured basis and cannot have been repaid by the debtor before the bankruptcy filing. In such cases, new value defense permits the creditor to claim a setoff against an avoidable preference in the amount of the “new value” provided. Alternatively, the contemporaneous exchange of new value may provide a defense when, for example, the debtor’s obligation to make payment is secured by a valid materialman, maritime, or other lien in favor of the recipient creditor and the creditor releases the lien in recognition of the payment. A lien release by a creditor may constitute a transfer of “new value” depending on (a) the creditor’s lien priority on the property burdened by the released lien and (b) whether or not the release of the creditor’s lien actually increases the value of the assets available for distribution to the other creditors.

The interplay between the ordinary course and new value defenses arose in a recently decided case out of the Western District’s Lafayette Division, Goodman v. Adriatic Marine, LLC (In re Gulf Fleet holdings, Inc.), 2014 Bankr. LEXIS 1121, No. 10-50713 (W.D. La. March 21, 2014). That action involved a debtor that owned and operated a fleet of offshore and fast supply vessels that supported oil and gas exploration and production companies. The debtor also operated an independent vessel brokerage business. The creditor owned and operated supply vessels that it leased to offshore gas and exploration companies through brokers like the debtor. At issue in the case were four payments received by the creditor on certain invoices during the preference period. As a broker, the debtor paid boat owners on a "pay when paid” basis, i.e., when it received payment from the ultimate customer. During the pre-preference period, the debtor paid boat owners approximately seven days after receiving payment from the ultimate customer. However, as its financial conditioned worsened during the preference-period, the debtor began making payments over 30 days from payment by the ultimate customer. Further, the particular “pay when paid” terms utilized by debtor and creditor were atypical for the oil and gas industry. These facts, coupled with the creditor’s inability to establish a pre-preference period baseline of dealings between itself and the debtor, were fatal to the creditor’s ordinary course defense.

Yet all was not lost. Despite the bankruptcy court’s rejection of the ordinary course defense, the aggrieved creditor successfully established the subsequent new value defense. This was because the creditor could show that it had allowed the debtor to continue to use its boat at a daily rate (i.e. the “new value”) after the creditor’s receipt of the preference-period payments. After calculating the cost of the debtor’s use of the vessel for the post-transfer, pre-bankruptcy period, the court credited that cost against the gross amount the creditor was expected to return as a preference to the bankruptcy estate.

In conclusion, if you suspect that you may be dealing with a customer or client teetering on the verge of insolvency or an ultimate bankruptcy filing, do not refuse payment! It is always better to be a paid creditor than an unpaid one. When defending a preference action, it helps to engage an attorney who is both experienced in creditors’ rights litigation in all phases of bankruptcy proceedings and knowledgeable regarding common transactions in your particular industry. At the outset of a preference action, your attorney will assess the merits of your potential defenses and use them to negotiate with the trustee, debtor-in-possession, or other representative of the bankruptcy estate to preserve a substantial portion of your hard-earned income. Given a bankruptcy estate’s typically limited resources, in many instances the estate’s preference claim against you may be able to be compromised for an amount that is significantly less than the amount claimed to be preferential payment.



 

The views expressed in this document are solely the views of the author and not Martindale-Hubbell. This document is intended for informational purposes only and is not legal advice or a substitute for consultation with a licensed legal professional in a particular case or circumstance.
 

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Author
 
Lacey E. Rochester
Practice Area
 
Bankruptcy
 
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