Supply Chain Bankruptcy Preference Releases: Good News for the Credit Team, But Watch for the Claim Offset, By: Scott E. Blakeley, Esq.

As originally published in the Credit Research Foundation 2Q 2018 Credit & Financial Management Review


In managing credit risk with an insolvent customer, the seasoned credit team also appreciates not just the A/R risk, but the preference risk should the customer file bankruptcy, or an out of court liquidation such as an Assignment for Benefit of Creditors. In some settings, suppliers may have larger exposure with preferences than with A/R. The welcome news for suppliers is that a number of large Chapter 11 filings have included supplier preference releases as part of their negotiated exit from Chapter 11. But with a provision in a Chapter 11 that provides for a preference release, suppliers holding priority claims should be mindful that the debtor may take back the supplier chain preference release through a reserved claim objection.

The Bankruptcy Preference

The Bankruptcy Code vests the trustee with far-reaching powers to avoid payments to suppliers within 90 days prior to a bankruptcy filing, and is one of a debtor’s most potent weapons to discourage a supplier’s collection strategy of racing to the courthouse to seek a judgement against the insolvent customer.

Supply Chain and One-Off Preference Release

Several high-profile companies have exited Chapter 11 with a plan of reorganization that provides for release of preference actions against the supply chain. Recent case examples include Rue 21, Haggens Supermarkets, Gordmans and Central Grocers. These cases highlight the Chapter 11 exit strategy in two settings: (1) a sale of assets, with an asset purchase agreement negotiated between the debtor, the buyer and creditors’·committee, that includes a preference release; or (2) an operating plan negotiated by the debtor, secured creditor and creditors’ committee that includes in the Disclosure Statement and Plan, a preference release. In both settings, title supplier qualifies for the preference release by offering credit terms for their product or service to the buyer or reorganized debtor upon exit from the Chapter 11.

If the debtor does not propose a supply chain preference release, the supplier may seek to negotiate a preference release only for its own potential liability. The one-off preference release is commonly through a negotiation of supplier trade terms in exchange for early payment of the supplier’s 503(b)(9) claim.

With the sale of asset cases, a Trust is created for purpose of retaining the estate’s preference actions and sale proceeds. The party responsible for the Trust’s assets is often referred to as a plan administrator. The responsibilities of the plan administrator are to maximize the Trust’s assets and limit its liabilities. One way to limit liabilities against the Trust is through plan administrator objections to claims submitted by suppliers.

A claim objection can be such things as books and records-the debtor’s reconciliation of the supplier’s claim does not match, or a late filed claim. Another strategy for the plan administrator to reduce claims is object to a supplier’s claim based on the supplier having received a preference. But does such an objection have merit where the Plru1 provides for a supply chain preference waiver? Is such an objection, selective enforcement of the preference powers as these types of claim offsets are commonly asserted against suppliers, asserting 503(bX9) claims?

Claim Objection Based on Preference

A plan administrator may object to a supplier’s claim, most likely a 503(b)(9) claim, under section 502(d) of tl1e Bankruptcy Code. Section 502(d) provides, in pertinent part, that “the court shall disallow any claim of any entity from which property is recoverable “under the preference statute, unless the preference is repaid.

How might a plan administrator support a section 502(d) claim objection where a debtor under a confirmed Plan releases suppliers from preferences?

For example in In re Gordmans, the confirmed Plan (at Article VII. paragraph F) provides:

Any Claims…recoverable under section …547 of the Bankruptcy Code, shall be deemed disallowed pursuant to section 502(d) of the Bankruptcy Code…

However, Article VIII, paragraph C of the Plan provides an unconditional preference release to suppliers from preferences. Thus, the question for a supplier holding a 503(bX9) claim is whether a plan administrator may disallow the supplier’s claim under section 502(d) on the grounds of an alleged preferential payment, even though a preference action cannot be filed as a result of the preference release.

Does the Legal Authority Support the Supplier Dealing with a 502(d) Claim Objection?

In most Chapter 11 cases, suppliers holding non-priority claims generally do not receive a distribution. Rather, only those suppliers holding priority claims. Generally 503(b)(9), receive a distribution. Therefore, in most Chapter 11s, the plan administrator’s focus with claims·objections, including 502(d) objections, is against priority claimants.

Fortunately, the majority of courts hold that section 502(d) does not apply to 503(b)(9) claims. In re Lids Corp., 260 B.R. 680, 683 (Bankr. D. Del. 2001) (“administrative expense claims are accorded special treatment under the Bankruptcy Code and are not subject to section 502(d)”); In re Durango Georgia Paper Co., 297 B.R. 326, 331 (Bankr. S.D. Ga. 2003) (“Section 502(d) does not apply to administrative expenses that are allowable under § 503”); In re Plastech Engineered Prod. Inc., 394 B.R. 147, 161 (Bankr. E.D. Mich. 2008) (“the allowance of claims
under § 502 is entirely separate from the allowance of administrative expenses under § 503”); In re Ames Dep’t Stores. inc., 582 F.3d 422,427-432 (2d Cir. 2009) (“[w]e hold that section 502(d) does not apply to admin istrative expenses under section 503(b)”); In re Tl Acquisition, LLC, 410 8.R. 742, 750-51 (Bankr. .D. Ga. 2009) (“Section 502(d) does not contain any language or reference which would make it applicable to administrative expenses of any kind”‘); In re Momenta. inc., 455 8.R. 353. 364 (Bankr. D. .H. 20 1 1) (“Because § 502(d) is inapplicable to administrative expense claims, including an expense requested under § 503(bX9). the claim shall be allowed”); Jn re Energy Conversion Devices, Inc., 486 B.R. 872, 878 (Bankr. E.D. Mich. 2013) (“1l1e Court is persuaded that the correct reasoning and views are those taken by the Second Circuit in the Ames Dep ‘t Stores case, regarding § 503(b) administrative expenses in general, and by the courts in the Plastech and Momenta cases, regarding § 503(bX9) administrative expenses in particular”); In re Quantum Foods. UC,554 B.R. 729, 735 (Bankr. D. Del. 20 16) (“Section 502(d), by its terms, does not include administrative expense claims. Conversely, § 503, which addresses administrative expense claims, has no provision similar to 502(d) disallowing administrative claims if the administrative claimant fails to satisfy a preference liability”).

The minority position is that § 502(d) applies to all claims, including administrative expenses. In re MicroAge, Inc., 29 1 B.R. 503, 508 (B.A.P. 9th Cir. 2002)(“[W]e believe that the better analysis is that §502(d) may be raised in response to the allowance of an administrative claim”); In re Circuit City Stores, Inc.,426 B.R. 560, 571 (Bankr. E.D. Va. 20 10) (“(T)he Court concludes that § 502(d) may be used to temporarily disallow § 503(bX9) claims”).

Supplier·Strategy to Ensure Priority Claim is Free from 502(d) Objection

If the supplier has a provision in a confirmed Plan that provides for a supply chain preference release, the next step is to confirm that a 502(d) claim objection is not preserved by the plan administrator. If so, consider objecting to that provision of the Plan.

If an objection to the Plan is not lodged, the supplier still has an alternative to preserve the priority claim. The court in In re Energy Conversion ruled that a provision in a confirmed plan does not override Congressional intent. In In re Energy Conversion, the Trustee requested the court delay payment of a supplier’s 503(b)(9) administrative expense until after the preference claim against it had been determined. The Court explained that, whatever discretion a court may have to allow a Chapter 11 debtor to defer paying allowed administrative expenses before a plan is confirmed, such discretion no longer exists once a plan has been confirmed; the confirmed plan controls when allowed administrative expenses must be paid.

Supplier Takeaway

As more large Chapter 11 debtors are considering supply chain preference releases, the supplier, especially one holding a 503(b)(9) claim, should be vigilant as to whether the plan administrator seeks to retain 502(d) claim objections. lf a supplier preference release is obtained, but 502(d) claim objections are retained, consider objecting to that provision. Otherwise, case authority supports the 502(d) claim objection be overruled.

Scott Blakeley, of Blakeley LLP, advises companies regarding creditors’ rights and bankruptcy law. His email:

Senior Credit Exec Forum: Boss wants to change terms on a customer slated for bankruptcy– any suggestions?

Editor’s note: The following article originally appeared in Credit Today, the leading publication for the credit professional, a CMA Partner. Click here for Special CMA Member $10 Trial!

Question: My boss wants to change terms on a customer that is slated for bankruptcy in the next few months. Other than stopping shipment, any suggestions?


Credit Manager, Game Manufacturer


Credit card, C.O.D or prepayment are just few of the terms you can change the customer to.


Credit Manager; Industrial manufacturer

Put them on 100% pre-pay. There’s no guarantee that the courts won’t consider it preferential payment, meaning you’d eventually have to pay a small amount back, but that only happened to us once.

Credit & Collections Associate; Industrial manufacturer


Prepay should never be considered a “preference payment” since by definition, preference has to be a payment on antecedent debt. Prepay is your safest option.

If you don’t choose prepay/COD and instead you change terms to something shorter, you will set yourself up for a preference suit and you will lose your ordinary course defense. You would still have New Value defense if your boss insists on offering shorter terms.

Director-North America Credit Operations; Consumer products manufacturer


If you’re sure that bankruptcy is imminent, our policy is to change the account terms to prepay and only accept credit card or certified funds/wire transfers for new orders. This is not considered preference. Once the bankruptcy is received; as long as its not a Chapter 7, we suspend the current account. We will open a new account again on a prepay basis once we receive notification from the court that the bankruptcy workout is accepted. It remains prepay terms until we’re able to assess the performance of the company. DIP checks are accepted and we continue to sell as long as the comfort zone isn’t ruffled. If suspicion of a change to Chapter 7 is in the horizon we do take precautions on sizeable orders.

Credit Manager, Household products manufacturer


Further to the below point, if you offer Net 20 day terms (or less) and they file, you may be protected by the administrative claim provision 503(b)9 of the bankruptcy code (assuming it’s a Chapter 11 reorganization).
Each case is different, but Admin Claims receive a higher priority and are often paid 100% for any shipments made within 20 days of the bankruptcy filing.

– Manager, Credit & Receivables; Industrial manufacturer


You can also work out percentage payment at the time of the order and full payment before shipment.

Credit Manager; Manufacturer


Prepayment is the safest option as it wouldn’t be considered a preference payment.

Credit & Collections; Medical equipment maker


This article originally appeared in Credit Today, the leading publication for the credit professional.
Click here for Special CMA Member $10 Trial!

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.