How to Better Prepare Against Preferences

Preferences can be a daunting challenge for creditors but Bruce Nathan, Esq., of Lowenstein Sandler PC of New York, presented information on how to better defend against them. The information was disseminated during a CMA webinar Feb. 12, 2007 entitled, “Preferences: Defenses That Can Reduce Exposure and Case Law Update.”

Nathan, a private attorney who specializes in bankruptcy law, noted the large amount of case law on preferences over the last year, and noted how bankruptcy cases are now making their way to court under the authority of the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 (BAPCPA). One big change under BAPCPA cited by Nathan was that the “ordinary course of business” defense against preferences is more advantageous to creditors. In defining a preference, Nathan said that generally it is a transfer of property of the debtor to or for the benefit of the creditor on account of existing debt owed by the debtor before the transfer was made. Furthermore, to be a preference, the transfer has to be made while the debtor is insolvent, it must have been made within 90 days before filing of the bankruptcy petition and the transfer must enable the creditor to receive more than he would receive in a liquidation.

Defenses to preferences are found in section 547(c) of the Bankruptcy Code, Nathan said. He pointed out that generally no preferences are applied to COD payments. Also, creditors can rebut the presumption of insolvency that is afforded debtors within 90 days of a bankruptcy filing, although that may be difficult to prove. “If you have financial statements that show a company (filing bankruptcy) was solvent close to that 90-day period of presumption of insolvency, you may make a case,” Nathan said. “A court, in determining insolvency, may include assets and liabilities that aren’t on a balance sheet.” Nathan also noted that those creditors defined as insiders, are exposed to a longer preference period of one year. Nathan advised creditors who receive preference claims to review their payments from that debtor within the last 90 days prior to the filing of the bankruptcy. He pointed out that some trustees just look at the check register of the debtor and send out preference demand letters to those creditors listed on the debtor’s check register during that 90-day period. However, while a payment may have been listed on a debtor’s check register, the creditor may not have received it. On the extemporaneous exchange of a product, which is new value, for payment, as in COD transactions, Nathan warned that if the check bounces and is replaced, the replacement of the check is considered an extension of credit. In that case, a preference claim could be made on that transaction. He also said, “The COD claim is only for goods that are exchanged for payment, not for the payment of old invoices.”

The ordinary course of business defense against preference claims has now become easier under BAPCPA Nathan said. “Under the old statute, there were a number of things that could cause the loss of the ordinary course of business defense.” Under the old law, a creditor had to prove a payment was made in the ordinary course of business with that customer and within the industry. He noted that if a creditor was doing business for the first time with a customer, there would be no payment history to establish an ordinary course of business with that customer. “Some courts would say the first transaction couldn’t be viewed as ordinary course of business.” Now creditors have to show that a payment was ordinary between that creditor and customer or that it was ordinary for the industry.

One of the attendees of the teleconference asked Nathan if trustees couldn’t be sanctioned for merely sending out preference demand letters from a debtor’s check register. “This is an abuse and it’s unfortunate,” Nathan said. “There are some circumstances where sanctions can be assessed. There are a few judges that have ruled that with obvious defenses, abuses have been committed.” However, he noted that it is difficult to have a judge sanction a trustee regarding sending out preference claims. “A judge would only sanction if you went to trial and won.” Another attendee asked a question about preference claims having to be related to a payment in the amount of $5,000 or more and whether that amount refers to individual payments or total payments? Nathan answered that it refers to lump sum and not each individual payment from a debtor.

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