Bankruptcy Preference Creditor's Digest

The Preferential Payment or Transfer

From the perspective of the debtor’s preference claim representative (the debtor in possession, creditors committee or plan representative (in the case of a reorganization)) or a Chapter 7 trustee (in the case of a liquidation), the identification of a bankruptcy preference payment follows a fixed routine. The starting point is simply a cash disbursements report that covers the period starting on the 90th day prior to the bankruptcy filing. This represents the universe of possible preference claims.

The slide below shows a basic time line for identifying a bankruptcy preference payment. You can click on the slide to see it in full page. The portion in green is the “information zone“. The information zone is a phrase coined by us to describe the period during which the facts were established that should resolve the issue being considered. In this case, the green highlights the information zone for the identification of a payment that may be found to be a bankruptcy preference payment.

How to Count 90 Days

By definition, a preferential transfer in bankruptcy is any transfer “on or within 90 days before the date of the filing of the petition.”  Bankruptcy courts generally hold that Federal Rule of Bankruptcy Procedure 9006(a) applies in making this calculation.  That rule simply says that, in counting any period, you exclude the date of the triggering event and include the last day.  The event in Section 547(b) clearly seems to be the date of the filing of the petition.

Some bankruptcy courts have had a problem counting backwards under Rule 9006(a).  The majority view is to count backwards, excluding the date of filing.  There are some jurisdictions that say that you should count forward from the date of transfer.

We are unable to identify a scenario (theoretical or otherwise) where forward counting gives a different result than backward counting.  This forward versus backward counting issue arose because Federal Rule of Bankruptcy Procedure 9006(a) says that if the last day of the period being counted is a weekend or holiday you go to the next business day.  That issue seems now to be pretty well resolved, and the courts have consistently held that the preference period is not extended if the 90th day falls on a weekend or holiday.

The Broad Concept of a Transfer

A “transfer” is anything of value, whether or not tangible, that the bankrupt customer gave any creditor or gave up for the benefit of a creditor for any reason. A payment is just one type of transfer. There are many types of transfers. For example, if the customer gives a supplier a security interest in its inventory (even inventory originally provided by the supplier), the giving of that security interest is a transfer. Also, if during the bankruptcy preference period bankrupt customer returns to a supplier goods that it can not pay for, that return is a transfer.

The debtor’s claim representative can, and in all likelihood will, review the debtor’s vendor ledger during the preference period and, if there is an unexplained reduction in accounts payable, make further inquiry as to why. Other types of preferential transfers inevitably turn up just in the ordinary course of a bankruptcy. A classic example is where a supplier, immediately prior to the customer’s bankruptcy filing, is allowed by the customer to “repossesses” raw material inventory previously delivered to the customer.

Sometimes a preferential transfer escapes identification and the debtor’s claim representative brings a preference claim based only on payments made during the preference period. In this event, the potential preferential transfer claim represents a latent preference liability for the supplier. It is imperative for a supplier to tell its counsel (and counsel always should ask) whether the is any preferential transfer exposure before deciding on a course of action in negotiating a threatened bankruptcy claim.

A bad scenario can develop were a previously overlooked preferential transfer is discovered by the debtor’s claim representative during the prosecution of a preference claim. Hypothetically, the lawyer who thinks he is defending a preference claim based on payments totalling $50,000 might suddenly find that the exposure just increased to $150,000.

In the above video, we discuss the identification of preference payments, the information zone regarding these payments and the application of these concepts to a simple example.

Click on the following links to see more articles on "avoidable transfer elements, bankruptcy preference ". First Published December 2nd, 2008.