Preferential Claims Kick Businesses Already Down From Bad Economy
October 12, 2011

By Sahely Mukerji,

"The current U.S. Code 547 is extremely unfair and even more so in these economic times," Kris Vockler of ICD High Performance Coatings recently found.

Kris Vockler is a woman on a mission. She wants to change the U.S. bankruptcy laws.

Vockler, vice president of operations at ICD High Performance Coatings in Vancouver, Wash., recently received a letter from the law firm of Ackerman & Felberg LLP in New York stating that ICD must return the money that it received from Arch Aluminum and Glass Co. in payment for invoices during the last 90 days before Arch filed bankruptcy in Tamarac, Fla. Arch filed for bankruptcy in November 2009. In an ironic twist, ICD also is a creditor that was owed money by Arch.

"According to U.S. Bankruptcy Code Section 547(c)(e), money paid to us by Arch, up to 90 days prior to declaring bankruptcy, might be considered preferential and have to be given back to the creditor pool in the suit," Vockler says. "One bit I'm not sure of is how several entities connect to each other. First we have the group of creditors, us, and then you have a liquidation firm who started contacting all of us, asking for money back. I'm not 100 percent sure yet if the money going back goes to the creditor pool or if it's just a convenient way for a second law firm to gather funds from us all. I can only imagine it works similarly to a personal debt, where a credit company will pay for a fraction of what was owed and turn around and harass someone for the full amount. Hence, netting them a profit.

"Either way, the current U.S. Code 547 is extremely unfair and even more so in these economic times," Vockler says. "Although it started with the true intentions of ensuring company X didn't get paid preferentially over company Y just prior to a bankruptcy, it's misused in its current form today."

"I call this the 'double whammy,'" says Robert S. Bernstein, creditors' rights and bankruptcy attorney at Bernstein Law Firm, P.C., Pittsburgh. "Your customer files bankruptcy. You know you're not going to be collecting the rest of what you are owed anytime soon, if ever, and then you get this letter from someone representing the debtor's bankrupt estate demanding that you return a payment already received." He adds, "So not only do you have a dead account, but now you're supposed to send money back to the debtor's bankrupt estate."

In Vockler's case, all funds paid to Arch within 90 days before it filed for bankruptcy are under scrutiny, unless those payments meet certain criteria. "From what I understand, the criteria used in this case is 'did the creditor follow a methodology in collections that differed from the previous two years?' If a creditor doesn't have a good trail of how they tried to collect past due funds, they are pretty much seen as having gotten preferential payment, because they can't prove otherwise. … From what I've studied, this is the most common defense against having to give back funds as well as one of the most common ways to test if funds are able to be taken back."

A preferential transfer is "a transfer (payment, lien, title) that was: (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 customer's bankruptcy estate under Chapter 7 of Bankruptcy Code," Bernstein says.

"It's an incredibly unfair code, particularly in this economic climate," Vockler says. "On top of losing money, this is just ridiculous. It had altruistic intentions, but it needs more exceptions, a better way to calculate, something [to make this fair to all parties concerned." To elaborate, "let's just pick some example numbers, which in no way represent us," she says. "At the time of bankruptcy, your customer owes you $100,000, but now they won't be paying that but you will be able to be in a pool of creditors, in which you might see a percentage of that back. Next, you get notice from a liquidating firm that says your customer paid invoices in the previous 90 days, amounting to $50,000. They then ask you to send them a check. You then pay your legal counsel to argue that down, maybe down to only $10,000. Gee, just when you came to grips that you lost money, you lose more."

To protect your business from preferential claims, be on the lookout, Bersntein says. "Sometimes you can see it coming," he says. "You know the customer is destined for a bankruptcy, but you have some leverage that enables you to get a payment. Maybe that leverage is a collection action or a product the customer desperately needs. Whatever the leverage, you get a payment that might be preferential. If faced with the choice of taking it or not, take it! You can always give it back, but you may also have defenses or reductions that will help you keep the payment even if it is preferential."

The important thing is to take advantage of possible defenses by making sure that if you do get a payment and are giving something for it - more product, lien release, etc. - you do that in the right way to make sure you can use it to defend a possible preference claim, Bernstein says. "For example, if you are owed $50,000 that is past due and the debtor wants new product of $10,000, make sure that you deliver the new goods after you get the $10,000 check you are going to demand," he says. "In that way, you can argue both that the $10,000 was for the new goods and that the new good was 'new value' that you extended subsequent to the payment. That will allow you to reduce any claim of preference by the new credit that was extended after receipt of the allegedly preferential payment."

Another way to protect against a preference is to have liens on the assets of the customer in excess of the amount owed to you, Bernstein says. "Then you are not an unsecured creditor and not receiving."

If you do get a preference claim letter, "do not send back the money just because someone asked!" Bernstein says. "Make sure you consult with your bankruptcy counsel, be sure that you analyze your defenses. Even with no real defenses, there is always a possibility of settling for a reduced amount."

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