Defending Preference suits when a customer files for bankruptcy Some Protections Available to those being sued.
By Steven R. Neuner Esq.
Neuner and Ventura LLP, Marlton, New Jersey
June 22, 2011
What is Preference?
When a customer (or “debtor”) files for bankruptcy, brokers, shippers and intermediaries are often a target of “preference” suits, to “avoid” and obtain a judgment for payments they received within the 90 day “preference period” just before the bankruptcy filing. These suits are usually brought by bankruptcy trustees or creditors committees, on the theory that by forcing a refund by those who got “preferred” payment of their debts while others went unpaid, the money can be “put back into the pot” so that all creditors will receive more even-handed payment on their claims. Whatever the results for others, for the person being sued who supplied goods or services for which payment was justly made, these suits “add insult to injury”.
In 2005, Congress placed some important limitations on when and where these preference suits can be filed. First, where the debtor’s obligations are not primarily “consumer debt” preference suits to recover payments or transfers cannot even be filed for unless the total being sued for is at least $5850.00. This is lowered to $600.00 if the debtor’s debts, including mortgages and other secured debt are primarily for personal, household or family use. Secondly, preference suit can only be filed in the federal court district in which you, the defendant reside whenever the suit is to recover less than $11, 725.00 in business debt, and where the defendant is not an “insider” (ie. a third party and not a shareholder, officer, party in control or someone else with a close relationship to the debtor). If the suit is based on a “consumer debt” the threshold is $17,575.00 . Practically speaking, this means the trustee must come to you and sue you in your local federal courts. This reduces your expense and increases the trustee’s, who must hire out of state counsel. If the suit or demand is under these numbers, you or your attorney should insist on compliance with these mandates.
There are several defenses you can use to reduce or escape liability. We will cover only two. The first is the “new value” defense. Under this defense, if after the payment or transfer to you, you made a later delivery of goods, services, or other “money or money’s worth” for which you did not receive payment, you are entitled to credit. This is because any “improvement in position” you derived from the original payment is reduced or offset by the later payment or value you gave to the debtor. Generally, courts look at whether you were still unpaid when the bankruptcy was filed. If you got paid for the later delivery, you may not get credit, although several cases in the Third Circuit (where New Jersey and Pennsylvania are located) have allowed credit where you got paid but the payment is itself an avoidable preferential transfer.
The other common defense is the “ordinary course of business” defense. To succeed here you need prove only one of the following:
a. That the debt repayments were made in the ordinary course of business; OR
b. Proving they were made according to ordinary business terms,
Generally, payments are “made in the ordinary course of business” if they are consistent with your other dealings with this customer, are within the reasonable range of normal dealings and are not the result of collection threats or suits. Payments that are the result of coercion or your attempt to take advantage of the customer/debtor’s financial need or condition may fall outside what is “ordinary”. The focus here is a comparison of your conduct or payment practices with this customer before the 90 day preference period with the payments made during that period. For example, if the payments before the 90 days were made 45-70 days after invoice, and the “preference” payments within that 90 days followed the same pattern, a good case might be made that they were “made in the ordinary course of business”.
The other way to succeed, even if you can’t pass the first test outlined above, is to prove that the payments and your dealings with the customer were consistent with “industry practice”, namely what others in a comparable industry as yours dealing with customers comparable to yours were doing. This usually requires some “expert testimony” concerning the relevant practice. This expense no doubt prompted many a settlement, but the expert opinion could well be founded on the knowledge of people in your organization who follow industry collection practices and trends.
Needless to say, careful record keeping is important. Your best evidence might be in your own files and records. Clients of ours who keep good statistical records can use them to show their ordinary practice for customers as a benchmark of comparison. Having access to industry statistics and collection practices is valuable. Your credit manager should be able to develop these contacts.
But at the end of the day, the best way to avoid preference suits is to maintain a firm and consistent policy for all customers and carefully monitoring those who fall behind. Firm and appropriately aggressive collection policies should not be avoided even though these might later lead to a preference suit. It is better to collect and later have to deal with such suits than not to be paid.
No matter what, these types of claims and suits should be taken seriously and not ignored. Prompt action in seeking out an experienced and qualified bankruptcy attorney is essential. So is compiling records to prove your case. Indeed, as soon as you become aware of a customer filing bankruptcy or threatening to do so, you should promptly secure, backup and preserve all your records of your dealings with that customer, including all emails.
While this article provides a generalized introduction to some of the legal principles, this area of the law is complex and very fact-sensitive. How each situation plays out requires individualized personal advice and counsel. How the courts might apply the law to your case might be complicated by issues or factors not discussed above. The right result requires careful analysis and early attention by you..
About the author
Steven R. Neuner Esq is a Certified Business Bankruptcy Specialist (American Bankruptcy Board of Certification). He regularly represents creditors, trustees, and debtors. A bankruptcy trustee in New Jersey since 1987, he has handled numerous preference suits, both as plaintiff’s attorney and as defense counsel. His practice takes him throughout New Jersey and Eastern Pennsylvania. He can be reached at (856) 596-2828 or email@example.com. For more information, visit his website at www.nv-njlaw.com.
1 All numbers are effective April 1, 2010 until March 31,2013.