Avoidance Actions In Bankruptcy Law: Part I

A primary purpose of a bankruptcy proceeding is to gather all of the assets of a debtor for the distribution to creditors in accordance with bankruptcy principles. One such principle is that a debtor may not “prefer” one creditor over another. With this goal in mind, a bankruptcy trustee may seek to “avoid” or undo certain transfers made during the 90 day period immediately before the bankruptcy petition is filed, commencing the bankruptcy case. If successful in this action, the money from the challenged transfers will be pulled back into the estate to be distributed pro rata to unsecured creditors. 

A preferential transfer is a payment: (1) to or for the benefit of the creditor, (2) for or on account for an antecedent debt owed by the customer before the payment was made, (3) made while the customer was insolvent, (4) made on or within 90 days before the date of the Bankruptcy Petition, and (5) that such payment enabled the creditor to receive more than it would receive if there was a liquidation of the debtor’s bankruptcy estate under Chapter 7. (11 U.S.C. § 547)

Some common defenses to preference actions include:

  • Contemporaneous exchange: This applies to situations where the debtor provides payment for goods or services at substantially the same time they are received and thus it is not subject to avoidance as a preference. This is because a preference requires that the payment be received on account of “antecedent” debt. If you are receiving an item of a certain value and paying for it contemporaneously, there is no antecedent debt involved in the transaction, and thus it is not subject to recovery as preferential payment.
  • New Value: If after receiving a “preference payment” for goods or services, a company then delivers additional goods or services to a debtor, the value of those items offset the preference amount dollar for dollar. For example, if a debtor pays money for products ordered within the 90 day preference period, and then the creditor sends you additional products prior to the petition date, the money which has already been paid cannot be taken back into the estate because this debtor has provided “new value,” for which no payments have yet been made.
  • Mere conduit: If a debtor transfers money to an entity that does not exercise dominion or control over it, but instead transfers it to another entity, the initial recipient of the payment may be able to assert the defense that it was a “mere conduit” as opposed to a transferee.
  • The ordinary course of business defense: A creditor may not have to return preference payments if the payment was consistent with the historical business relations between the debtor and creditor and followed the industry norms.

The vast number of recovery actions for preferences are settled before litigation. If you find yourself being sued for the recovery of preferential payments, speak to an attorney with experience in bankruptcy matters. Your lawyer will:

  • Analyze your preference exposure;
  • Determine whether you have any applicable defenses;
  • Discuss settlement options with you;
  • Discuss litigation strategy if settlement is inadvisable.

Join me next time when I’ll take you to the intersection of bankruptcy and divorce.

Adrienne WoodsAdrienne Woods
The Law Offices of Adrienne Woods, P.C.

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