Most business owners have experienced a client going through bankruptcy. If a client goes into bankruptcy and still owes you money, then you usually accept the loss and move on. However, in some cases Creditors actually get sued for the return of money by the Trustee. They don’t understand how this can happen; because they didn’t do anything wrong and usually they are still actually owed money by the debtor.
Usually in these instances, the bankrupt client and creditor had set up a payment plan for the debt, prior to filing bankruptcy. While payment plans to resolve delinquent debts can be good for a creditor in non-bankruptcy scenarios, it can be bad news for the creditor if the customer later files for bankruptcy. Under 11 USC §547 the trustee has what is called “avoiding powers.” There is a presumption that the debtor was insolvent during the 90 day period that preceded the filing of the bankruptcy petition. Therefore, the Bankruptcy Trustee has the ability to look back at the transactions that occurred in the 90 days prior to the bankruptcy filing, and sometimes longer. This is generally called the “look back period”. The look back period can be extended up to 1 year if the creditor is considered an “insider”. During the look back period, if payments were made to a creditor and the following conditions are present:
- The transfer for or on account of an antecedent debt owed before the transfer was made (i.e. not a payment contemporaneously made for new goods and services)
- Transfer was made while debtor insolvent
- Transfer made within 90 days of petition date
Transfer enabled creditor to receive more than it would have received had the transfer not been made and creditor received distribution in a chapter 7 bankruptcy then the Trustee can attempt to take back payment of those funds made during the look back period. This process is called ”Avoidance of Preferential Transfers” and it is designed to restrict the debtor’s attempt to prefer one creditor over another. In other words, it brings those payments back into the “pie” of the bankruptcy estate which will be divided up and paid to the unsecured creditors on the basis of their priority and pro rata share. The time frame that the Trustee has to bring an action to avoid a preferential transfer is set by statute ( 1 1 USC §546). Calculation of the time period under the statute is technical, but a good rule of thumb is that the Trustee must bring the action before the sooner of: (i) 2 years after the filing of the bankruptcy; or (ii) the elate the bankruptcy case is closed.
There are certain affirmative defenses that the Creditor can assert against a Trustee’s action to take back payments made to the creditor. Some of the most commonly invoked defenses are (i) transfers that are a contemporaneous exchange for new value given to the debtor; (ii) transfers made in the ordinary course of business or financial affairs or made according to ordinary business terms: and (iii) new value given by the creditor to the debtor after the transfer. In many instances it pays to consult with a bankruptcy attorney about which defenses, if any, may be applicable to your situation. In many instances the creditor can defend against the action or negotiate a settlement with the Trustee. Generally settlements are far less costly than having to return the full amount of the payments.