Comments on US Bankruptcy Code “ Preference Claims”

Comments on US Bankruptcy Code “Preference Claims”: defenses against by its clients, and the importance of US Trade Credit Insurance policy wordings.

Over recent years there has been a noticeable increase in the number of US “Preference Claims” pursued and subsequently allowed under the US Bankruptcy Code.

AU North America are actively involved in all insolvency/ bankruptcy claims for its policy holders, including the management of “Preference Claims” and recovery through Trade Credit Insurance policies.

It is most important that our clients consider and utilize defenses against “Preference Claims” that currently in the US, are almost certain to follow a debtor bankruptcy event.

It is equally important that any credit insurance policy is worded correctly under US State Insurance regulators rules, and that such policies can respond effectively to these claims.

In many bankruptcies, a debtor’s most significant asset is its “Preference Claim” against its creditors. The bankruptcy defines a preference as: The transfer of an interest of the debtor in property:

  • to or for the benefit of a creditor,
  • for or on account of an antecedent debt owed by the debtor before such transfer was made,
  • made while the debtor was insolvent,on or within 90 days before the filing of the bankruptcy petition (or within one year before the filing if the transferee creditor was an insider),
  • that enables the creditor to receive more than such creditor would have received if the case were a Chapter 7 liquidation proceeding.
  • The transfer of an interest of the debtor in property,
  • to or for the benefit of a creditor,
  • for or on account of an antecedent debt owed by the debtor before such transfer was made,
  • made while the debtor was insolvent,on or within 90 days before the filing of the bankruptcy petition (or within one year before the filing if the transferee creditor was an insider),
  • That enables the creditor to receive more than such creditor would have received if the case were a Chapter 7 liquidation proceeding.

Contemporaneous Exchange for New Value

Under the following example, its possible to avoid a “Preference Claim” challenge”, Since the terms fall into what is termed a “new value” defense.

Example:

Within the 90 days preceding the debtor’s filing of a bankruptcy petition, creditor sends debtor a shipment of goods, and one week later debtor transfers payment to creditor. Creditor applies the payment to the goods shipped one week previously, and debtor and creditor intended that this exchange be substantially contemporaneous. Most courts will find that this falls within the contemporaneous exchange defense.

Ordinary Course of Business Defense
Example:

Creditor’s arrangement with debtor is that debtor pays on 60-day net terms, and this is a customary term in the industry. However, over the course of the prior two years, debtor frequently paid within 65 to 75 days. In the 90 days prior to filing bankruptcy, debtor makes payments to creditor which are within 55 to 75 days net. Although the agreed upon terms were 60 days net, because debtor and creditor established a course of payment which was often 65 to 75 days net, if this occurred frequently enough, and if this was ordinary within the industry, most courts would probably find that none of the payments received within the 90 days prior to filing were a preference.

Subsequent New Value Defense

Example:

Creditor receives a potentially preferential payment in the amount of $50,000. Creditor subsequently ships to debtor $60,000 worth of goods. Debtor then files bankruptcy. The result will be that the $50,000 payment was not a preference.

Most clients need to know exactly where they stand before engaging in any correspondence with any party representing the debtor.

Know Your Enemy – Parties Responsible for Collecting Preferences


The strategies for defending against a preference claim are clearer if you understand who your opponent is and what his incentives are. Preference claims may be brought by any of several parties. These include the attorneys for:

  • The debtor
  • Court appointed trustee
  • The creditors committee
  • Collection firm

Regardless of the party bringing the claim, you should be aware of the following facts.

(1) In many cases the trustee, attorney or collection firm is employed on a contingency or other incentive based system. This generally encourages the claimant to try to settle claims quickly while spending as little time as possible.

(2) The debtor’s records are generally a mess. As a result, initial preference demand letters are usually generated based merely on the debtor’s check register, with no analysis of creditor-preference defenses.

(3) The claimant is usually pursuing numerous other preference claims. You aren’t the only one. This leads to several issues which may effect your strategy:

(A) Early settlements may set a precedent for future settlements. The claimant may, therefore, show less flexibility at the beginning than it will after most claims are resolved.

(B) Big claims get more attention than small claims. The amount of attention your case receives may have more to do with the comparative size of your claim than with its validity. The claimant may initially ignore or not be aware of any special facts concerning your claim. Additionally, you may be able to resolve a “small” nuisance size claim at a round number regardless of the strength of the preference claim or the weakness of your defenses.

Practical Strategies for Defending Preference Claims

It’s a good idea not to rush into any action, and delay is the best policy.

Our clients have received the funds already. In some cases if you ignore the initial demand letter you may never hear from the claimant again.

Make The Claimant Disclose Its Legal Theory Before You Raise Your Defenses.

It is easier to defend a claim if you know the other side’s factual and legal arguments. Therefore, a good strategy for an initial written creditor response is a letter to the claimant stating that your company records do not show any receipt of payments that would be considered a preference. The letter should ask the claimant to furnish you with any information they have supporting their preference claim against your company.

Analyze Your Defenses

Once you receive available information concerning the preference claim you should analyze your defenses. If the claim is large, you may wish to retain the services of a bankruptcy attorney. A detailed letter to the claimant setting forth defenses to all claimed amounts is usually the next step. You may wish to include a very low settlement offer in this letter.

Cost-Benefit Settlement Analysis

Settlement strategies depend on the size of the claim and the strength of your defenses. Even if you are “dead-in-the-water” without any viable defense, you still have negotiating power. You have the money. They don’t. Don’t ever offer 100 cents on the dollar. In almost all cases, the claimant will take less than the obvious preference amount just to settle the case. How much less depends on the facts of the case and the size of the claim.

Keep in mind any additional influence you have with the debtor. If your debtor is attempting a chapter 11 reorganization, you may be able to use your other negotiating points (e.g. your willingness or unwillingness to sell on shortened credit terms to the post-petition debtor) to help reach a satisfactory settlement of the preference claim.

Additionally, you may be able to link resolution of any reclamation claim you have to resolution of the debtor’s preference claim against your company.

Finally, you may be able to extend negotiations to include the amount of your company’s claim in the bankruptcy and the classification of that claim in the debtor’s plan.

If you reach a settlement, be careful what you sign. Do not sign a full written release if you have additional claims against the debtor. At the very least, any amount you pay as a preference should be added to your bankruptcy claim against the debtor.

Do not make your best offer at the beginning. Unless the claim is small and you just don’t want to be bothered, start with a low offer and increase it only when necessary.

Conclusion

Curiously when mass mailings of preference demand letters are sent to trade creditors, some creditors pay in full, by return mail! AU North America never advises our clients to respond to a preference demand letter by sending a check.

A creditor who utilizes the preference defense strategies discussed here should be able to reduce the amount it has to pay in response to preference demands. A basic knowledge of the preference law, preference defenses, and the preference demand and recovery procedures provide the foundation for using these preference defense strategies.

Any good defense of a “Preference Claim” wording actually supports credit insurers, who may have included “Preference Claim” coverage in their policy through specific endorsement. A good defense is expected by insurers, and a strong strategy of defense against “Preference Claims” by our clients forms a first line of defense, which should be discussed and acknowledged by credit insurers.

Trade Credit Insurance policy wordings do not always contain a “Preference Claim” coverage, or indeed if they do, the wording may not be adequate or effective in the State the policy is issued. It is vitally important to obtain the opinion of a US specialist insurance broker over any Trade Credit Insurance “Preference Claim “policy wording.

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