Burbage & Weddell LLC Defending Bankruptcy Preference Claims Nationwide: 888.547.5170
The bankruptcy preference claims process can be broken down into 3 stages. While these stages often overlap in terms of time, the stages remain distinct in terms of the primary activity being conducted.
A supplier or other unsecured creditor who has been paid in the 90 days before the bankruptcy filing (the “Preference Period”) should understand the 3 stages and the opportunities within each stage to define, lessen or even eliminate bankruptcy preference exposure. The 3 stages are:
This article provides a brief discussion of each of these stages and the steps a creditor should take as part of each stage. The following are links to additional materials regarding the process of bankruptcy preference resolution:
The assessment stage is the initial stage of the bankruptcy preference resolution process. At the outset, each of the creditor and the debtor will be conducting assessment activities from totally different perspectives.
Both before and after the bankruptcy filing most business debtors will be engaged in a general, broad brush assessment of the potential size of bankruptcy preference recoveries, if and when bankruptcy preference claims will be brought, and the role of avoidance actions in the overall bankruptcy strategy. In this initial assessment the debtor is not likely to be considering the potential for a preference claim against any one creditor.
The first action of a creditor in the assessment stage should be (1) to determine the amount of the payments it received from the debtor during the 90 days prior to the bankruptcy filing (the “Preference Payments”) and (2) to evaluate the likelihood that the bankruptcy will result in preference claims being brought.
If the total amount of all Preference Payments is less than the $5,850 threshold for the bringing of bankruptcy preference actions, then the decision can reasonably be made to limit further assessment activities. If the amount is more than this threshold, the creditor should take steps to preserve and assemble the information necessary to defend a preference claim.
The creditor should also make a preliminary assessment of the potential for preference claims. In our article “The Decision to Start Preference Recovery” we discuss the major factors that affect the decision to bring bankruptcy preference actions. We also note that in the instance where there is a “pre-packaged” bankruptcy filing, there historically is a very low likelihood that preference claims will be made. In all other cases, the risk that the course of the bankruptcy will be altered cautions against a creditor delay in conducting assessment activities even if the initial indications are that preference recovery will not be sought.
A creditor who has received Preference Payment but who waits for the demand letter or preference complaint before making an assessment may pay a hefty price in terms of additional time, cost and effort and may ultimately pay a price of not being able to defend the preference claim effectively.
Consider the following:
Additionally, absent early exposure assessment, the creditor can not decide what priority to give to the allocation of resources to assessment activities.
Finally, as we discuss in conjunction with other strategies to avoid bankruptcy preference claims, there may be opportunities for a creditor to influence its own fate. Unless there as been an early bankruptcy preference exposure assessment, the importance of pursuing these opportunities may not be appreciated.
As mentioned above, each of the debtor and the creditor starts the assessment process with the information it possesses. The creditor gets one early advantage. It gets a first, early look at the information the debtor has about Preference Payments.
In all bankruptcies, the debtor is required to file a report called the “Statement of Financial Affairs”, which is commonly referred to by the acronym “SOFA”. Schedule 3b is list of each payment or other transfer to any creditor (other than insiders) made within 90 days immediately preceding the bankruptcy filing if the aggregate value of all property that constitutes or is affected by such transfer is $5,850 or more.
If the information on the debtor’s SOFA Schedule 3b is not correct, and the errors increase the debtor’s exposure to bankruptcy preference claims, the creditor should contact the debtor or its counsel. While it is unlikely that a corrected schedule will be filed, the debtor may correct errors in the underlying data or, at a minimum, make note that the debtor has been advised that the information may be incorrect. This step can help a creditor avoid time, aggravation and costs later when the decision on whether to make a bankruptcy preference demand is being made.
After the initial Schedule 3b SOFA filing, the debtor’s assessment of individual claims against specific creditors waits until the direction of the bankruptcy is certain, a decision has been made that bankruptcy preferences will be pursued and the person or group who will pursue the collection of preferences is determined. We discuss this decision making process in the article The Decision to Start Preference Recovery.
Creditors generally think of the receipt of the first demand letter as the starting point for negotiation of bankruptcy preference claims. We discuss elsewhere on this website that there may be opportunities for the creditor to accelerate the negotiation process and improve the creditor’s odds for a successful resolution. We discuss some of these early opportunities in our article Timing of Negotiations.
Creditors are sometimes surprised when the first notice of a bankruptcy preference claim is service of an adversary proceeding complaint rather than a demand letter. While the instances are infrequent, there are bankruptcies where no opportunity to negotiate arises before the complaint if filed. This most often occurs when the 2 year deadline for bringing preference actions is about to run. We have also seen this occur where the debtor is trying to gain leverage to defeat some claim of the creditor, such as an administrative expense claim.
However the negotiations start, it is our experience that more than 9 out of every 10 bankruptcy preference claims are resolved through negotiation. Given these odds, negotiation strategy and tactics are critical and involving bankruptcy creditor counsel knowledgeable in bankruptcy preference law and practice can make all the difference.
An adversary proceeding is litigation – a lawsuit filed against the supplier in federal court to recover a preferential transfer. Like any lawsuit, an adversary proceeding can be intimidating.
Preference actions are often settled after the filing of an adversary proceeding and before the answer is filed. However, once an adversary proceeding is filed the timeline for resolution compresses. Additionally, the filing of the adversary proceeding complaint means that the creditor must determine the necessity of hiring local counsel – i.e. counsel licensed to practice law in the state where the bankruptcy is pending. The local rules of the bankruptcy court will specify if a creditor’s out of state counsel can appear “pro hac vice” without the participation of local counsel.
The following hypothetical time line illustrates the interaction of the above stages.