• Myths and Realities of Defending Against Preference Demands
  • December 16, 2011 | Author: Richard (Jay) J. Reding
  • Law Firm: Larkin Hoffman Daly & Lindgren Ltd. - Minneapolis Office
  • Due to the economic crisis of the past few years, many large and medium-sized businesses were forced to file for bankruptcy protection. Now, many businesses are faced with letters from bankruptcy trustees, or worse, a summons where the trustee is seeking liability for a “preference.” Faced with these demands, many businesses are failing to defend themselves, and incurring unnecessary liability. But acting quickly can help protect you and your business and settle preference claims short of expensive litigation.

    First, a small amount of background. A “preference” is a term of art in the bankruptcy world. A preference is defined under Section 547 of the Bankruptcy Code (11 U.S.C. § 547) as:

    1. A payment on an antecedent (as opposed to current) debt

    2. Made while the debtor is insolvent (which is assumed to be 90 days prior to the bankruptcy filing);

    3. To a creditor within 90 days of the bankruptcy filing (or one year if the person receiving payment is considered an “insider” of the debtor);

    4. That allows the creditor to receive more than they would have had the payment been made through the bankruptcy claims process.

    A Chapter 7 trustee or a debtor-in-possession in a Chapter 11 case has the right under the Bankruptcy Code to bring a preference action.

    By definition, payments to fully secured creditors are not preferences because creditor would not get more than they would have gotten through the bankruptcy claims process. But for a hapless unsecured creditor, a trustee’s preference demand can strike like a bolt out of the blue.

    There are many myths surrounding preference liability, four of which are especially common and especially dangerous for those who have either received a demand letter or been sued on a preference:

    It’s okay to do nothing. This is never a good solution to a legal issue. Eventually, the trustee will either sue on the preference and bring an action for default judgment. A judgment in bankruptcy court is enforceable as any other judgment, and sooner or later you or your business could face collection actions or a reduction in credit score. Doing nothing is not worth the risk.

    The debts were legitimate, so I shouldn’t worry. Many people who face preference liability have trouble understanding why the trustee is asking them to pay. The amount of money they got from the debtor was for a legitimate expense, so why can the trustee ask them to pay it back? But liability for a preference isn’t a matter of right or wrong, or whether the payments were improper in any way. Instead, preference liability is based on the fact that someone got paid more than they would have through the bankruptcy process, and the trustee has the right under the Bankruptcy Code to make sure that all creditors get paid fairly under the Code. A perfectly legitimate payment on a debt is still a preference, and a trustee can still demand that the bankruptcy estate be paid.

    I can deal with the trustee on my own. While some may be able to settle their preference liability on their own, that is the exception, not the rule. There are defenses against preference liability under Section 547 of the Bankruptcy Code that apply in many situations—but in order to settle your preference case quickly, it’s important to put your best foot forward. That means having someone representing you that knows the relevant defenses and can present them in a way that can settle your case.

    Hiring an attorney would be prohibitively expensive. The reality is that litigating a preference claim is an expensive and time-consuming proposition in many cases—but acting quickly can prevent the need for litigation.

    Dealing with a preference claim can be frustrating, and at times even frightening. But if you take action quickly, it is possible to settle a preference case quickly and with a minimum of expense.