By Alexander Barthet

Stay  in  business  long  enough,  especially  during  difficult economic  times,  and  you  will  inevitably  become  a  creditor  in  a customer’s  bankruptcy  –  a  disappointing   development   made worse  when  you  receive  a demand  asking  for  the   return   of a payment you recently received from that customer.  You may be tempted to ignore the request, believing that since you are actually entitled to the money, you’re excused from complying.  That would be a mistake, since money paid by a bankruptcy debtor may be challenged as a preference and subject to forfeiture.

The Bankruptcy Code seeks to protect all the assets accumulated by a debtor before it filed for bankruptcy.  This way, all other creditors are provided an opportunity to share fairly in the bankruptcy estate (debtor’s property).  No creditor should receive preferential treatment, obtaining more than an equal distribution of the debtor’s assets.  A one for all, all for one concept.

If money is paid to you within 90 days preceding a bankruptcy filing, or one year if you’re an “interested party”, it may be viewed as a preferential payment and subject to being taken back.  This is to prevent a debtor, who has a limited number of assets to satisfy its debts, from just paying certain preferred creditors (like those with whom it may wish to do business in the future). This could leave the remaining creditors with substantially less than what the preferred creditor received.

Of course, not every payment by a debtor can be reclaimed as a preference.  There are defenses, with the most popular being that a payment was made in the ordinary course of business.  As the term implies, this essentially provides for the avoidance of a preference claim if the monies paid, although paid within the preference period, were genuinely due and were paid when they were due.

You may be asked to prove this, showing that the monies received during this preference period were for a normal business transaction between you and the now bankrupt company (for example related to the shipment of goods or the rendering of services).  You can expect the bankruptcy trustee to review the timing of payments made by the bankrupt company both before and during the preference period to test   whether   the   payments   you   received   were   really   paid in   accordance with customary conditions of sale.  The trustee may even challenge your defense and explore whether you or the bankrupt company deviated from expected business