Bankruptcy - What you need to know about preferences

Posted by: cworrall on Wednesday, May 14th, 2008

The current economic climate is not great. The country is in a recession and credit markets are getting really tight. Even if your business is rock solid and your revenues have not been effected by the change in consumer behavior, you still might get hit with bankruptcy problems. Do you know what your risks are if one of your customers goes bankrupt?

If your customer pays you in an arms length transaction within 90 days of declaring bankruptcy, you may be required to return that payment to the trustee. Not only that, but the trustee has up to two years to reclaim that payment. This is defined in Bankruptcy Code §547.

Example, you sell a carton of widgets to ABC Store for $10,000. Thirty-five days later (about 10 days after they normally would have paid), ABC Store pays your invoice. Thirty days after that, ABC Store goes bankrupt. If you don’t have any outstanding invoices, you might not even know. A year and a half later, the appointed trustee demands the $10,000 back. Is this valid and legal? Yes, it is, and without an accepted defense, you will be required to return the $10,000 and file a claim against the debtor.

Defenses to the recovery of a preference are found in 11 U.S.C. 547(c).  They include:

These defenses have to have occurred before the customer declared bankruptcy and must be raised in an answer to a preference complaint. It is up to you to provide the proof that the defenses are valid.

So how can you protect yourself?

Once the customer has declared bankruptcy, you can only gather your documentation and find a good bankruptcy lawyer. However, if you suspect that a customer is having financial trouble and may go into bankruptcy, you should immediately contact a bankruptcy lawyer to determine what actions you can take to protect any payments that you have already received.

Topics: Corporate, Legal

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