Periods of economic uncertainty, such as the COVID-19 pandemic, create challenges not only in receiving timely payment for goods, services and other debts, but in retaining payments when dealing with customers or other obligors who may be on the verge of bankruptcy. A bankruptcy filing opens the door to preference liability, which could result in the obligation to return a payment or other property received prior to the bankruptcy.
A “preference payment” is any transfer, including money, by an insolvent party within ninety days of the filing of a bankruptcy. In California, a similar law applies to assignments for the benefit of creditors (“ABC”). Typically, a bankruptcy trustee asserts a “preference claim” against each of its creditors believed to have received an offending payment in an effort to equalize distribution of assets among similarly situated creditors.
Of course, “Getting Paid” is a primary goal for any creditor/business. Consequently, the “Golden Rule” of debt collection is a good one to follow: when offered the “gold” to pay a debt, take it. When receiving payment from a company or individual that may be in financial distress, the informed creditor understands its potential exposure and takes protective measures that may help ensure it “Stays Paid.”
Not every payment made within 90 days of bankruptcy or an ABC constitutes a preference payment. There are a number of statutory exceptions and defenses to preferential transfers. At the top of that list are payments to a fully secured creditor, payments received in the “ordinary course” of business, and payments received in exchange for “new value.” Fully secured status at the time of receipt of a payment is fairly straightforward. “Ordinary course” and “new value” payments are potentially more complicated.
A debt or invoice paid in a manner consistent with the customary business terms between a payor and payee is considered paid in the “ordinary course,” and exempt from preference liability. To determine whether a payment was “ordinary,” courts review closely the prior course of dealings and may consider industry standards. Creditors seeking payment from a company that seems to be on the “financial cliff” should be wary of the impacts of collection actions, such as extending payment deadlines or an unusually high volume of collections calls or e-mails, as these actions may result in a payment being considered out of the ordinary course of the parties’ business. An informed creditor will consider its history of dealings when pursuing collections and make an effort to stay within those “ordinary” parameters, so as to preserve a defense to a future preference claim. Creditors who pursue the “Golden Rule” with a likely insolvent debtor should do so with precautions (e.g., retain records evidencing “ordinary course”) until the preference period expires with no bankruptcy filing.
A creditor who provides “new value” in exchange for a payment or other transfer also can avoid preference liability. Generally, “new value” is an extension of further credit (e.g., money, goods, or services) to a troubled debtor. For example, a subcontractor behind on its account to a supplier may make a partial payment, and, in exchange, the supplier may agree to fill a new order for materials despite the continued account arrearage. The credit extended by the supplier in this case would support a “new value” defense to a future preference claim.
The above are a sampling of the defenses and issues to consider in the area of preference liability. Hopkins & Carley’s highly skilled team of creditor’s rights professionals is ready to assist you in creating and implementing strategies for receiving future payments, or in preparing an effective defense to a preference claim made against you.