March 28, 2023
By: Robert E. Kaelin, Daniel C. Cohn, Jonathan M. Horne, and Zachary J. Gregoricus
Your customer has filed bankruptcy, leaving a series of unpaid invoices in its wake. While unfortunate, you chalk it up to one of the many costs of doing business and move on to landing bigger and better accounts. Then you receive a letter from a bankruptcy trustee demanding you pay back monies you received from the customer within 90 days before the bankruptcy, adding insult to injury. Every dollar you received was in exchange for goods and services you provided. Do you really have to pay back the amounts demanded? Should you consult an attorney? Should you just ignore the letter?
1. Do Not Ignore the Demand Letter . . . But Also Do Not Pay
While the bankruptcy trustee may have a legitimate claim to recover, as a “preferential transfer” the monies you received, there are defenses that may limit or eliminate liability. If you ignore the letter and the complaint that follows, you probably will be held liable for the full amount of the demand, and the sheriff really will show up at the door to collect that amount, plus interest and fees. On the other hand, if you respond to the demand letter explaining your defenses under bankruptcy law, it is common that preference demands are resolved without litigation, and at a fraction of the amount originally demanded.
Do not make these two common mistakes: (1) Do not simply ignore the trustee’s letter and assume, incorrectly, that because you “didn’t do anything wrong” and were simply “paid what you were owed,” the demand is baseless and will not lead to litigation; and (2) Do not simply pay the demand because you do not want legal trouble. As frustrating as the demand may be – especially where the bankrupt company still owes you money – your approach should be the same as for any potential business expense: Figure out how to pay as little as possible to get what you need, in this case, legal peace.
2. Do Gather Your Records
The key to efficiently and effectively resolving a preference demand is substantiating available defenses with relevant business records. The three most common defenses are that a payment was: (1) made in the ordinary course of business; (2) a contemporaneous exchange for value; or (3) offset by new value provided after the payment was received.
The ordinary course defense generally applies when a payment is made in the ordinary course of business between you and the bankrupt company. In determining whether a payment was made in the ordinary course, courts consider the timing, credit terms, manner of payment and collection efforts surrounding the payment at issue, versus those same factors during the parties’ historical baseline period. Thus, to substantiate an ordinary course defense, you will need invoice and payment records showing the timing, manner and terms of payment during the 90 days before bankruptcy and during the 1 to 2 year “baseline” period before then.
The other two common defenses – contemporaneous exchange and subsequent new value – apply where you have provided valuable goods or services to the bankrupt company, either around the same time or after the alleged preference payment. To substantiate these defenses, you will need invoice and delivery records to confirm the timing and value of the bankrupt company’s receipt of goods or services. Other defenses may also apply depending on your situation, such as where the payment was a prepayment, or was fully secured by collateral.
3. Do Not Wait To Consult an Attorney
Upon receiving a preference demand, do not wait to consult bankruptcy counsel. Armed with the relevant information (put it on a spreadsheet if you can), experienced counsel can quickly size up the claim and potential defenses, provide an accurate estimate of potential exposure and devise the most effective strategy for resolving the claim. By contrast, once litigation has commenced, you will need counsel to represent you in the Bankruptcy Court, compounding your legal expense and increasing the ultimate price of resolving the claim. The key to success is for you to act promptly when you receive a demand letter. Murtha Cullina’s bankruptcy attorneys have successfully resolved thousands of preference claims, and have the experience necessary to provide you the most effective representation in each case.
Whether your business is facing financial challenges or you are doing business with someone who is – Murtha Cullina has an experienced Bankruptcy & Creditors’ Rights team with a proven track record to achieve your business goals in an efficient and cost-effective manner.
For more information, please contact:
Robert E. Kaelin at 860.240.6036 or rkaelin@murthalaw.com
Daniel C. Cohn at 617.457.4155 or dcohn@murthalaw.com
Jonathan M. Horne at 617.457.4085 or jhorne@murthalaw.com
Zachary J. Gregoricus at 617.457.4154 or zgregoricus@murthalaw.com
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