During the bankruptcy process, creditors of the debtor may find themselves in the particularly troubling position of being asked by the bankruptcy trustee to return money they had legitimately received from the debtor.
Trustees in bankruptcy are always looking out for what is known as a “preference” or a “preferential transfer.”
[Read more on what the Role of a Trustee is]
A Preferential Transfer is a payment of money or property to creditors on a pre-existing debt within the “preference period.” Typically, this period is 90 days prior to the bankruptcy filing, or one year if the creditor is an “insider.”
Whether someone is an insider is determined by looking at their relationship with the debt, and includes family members, corporate officers and the like.
In a Chapter 7 bankruptcy, “Preferential Transfer” actions are brought via a lawsuit in the bankruptcy court under section 547 of the bankruptcy code by the trustee against the recipient of the transfer. If successful, the trustee can undo and recover the transfer of money or property for the benefit of unsecured creditors.
A preferential transfer can come up in many scenarios. Common preferential transfer situations include debtors who repay friends or relatives on loans and small business owners and landlords who provide products or services to the debtor. If a customer falls behind on payments (as is often the case when someone is at risk for bankruptcy) and then makes a payment within 90 days prior to filing bankruptcy, the trustee may view this as a preferential transfer.
As one may imagine, preferential transfer actions are often particularly upsetting to creditors. The recipient of the transfer is often owed additional money that will not be repaid in the bankruptcy case and now has to return money legitimately received. Although the overall policy/purpose is to ensure that all unsecured creditors are treated fairly and equally pursuant to the provisions of the bankruptcy code, this practice seems unfair to the creditor.
So, what happens if the trustee has sued or threatened to sue you for having received a preferential transfer?
Prior to being served with a lawsuit, most creditors will receive a letter from the trustee demanding return of the allegedly preferential transfer. Just because you received such a letter does not mean that the trustee’s position is strong; you have the opportunity to defend yourself and keep the money you are rightfully owed. An experienced attorney can often find the problems & weaknesses in the trustee’s arguments and convince the trustee (or judge if the lawsuit has already been filed) to drop the case or work out a settlement between you and the trustee.
Even where all the elements of a preferential transfer are present, there are many legal defenses, most of which are very technical. The two most common defenses are “new value” and “ordinary course of business.”
NEW VALUE: This defense applies if the creditor receives a transfer and then subsequently advances additional credit to the debtor that remains unpaid on the date of the bankruptcy filing. Where such new credit is provided, it can be “offset” against the original preferential transfer, thus reducing or eliminating the creditor’s liability. The “new value” defense usually applies where there is an open account between the debtor and creditor; for example, a vendor who regularly advances products. However, it can also apply to a relative or friend who is repaid on a loan and then subsequently lends additional money for which he or she is not repaid.
ORDINARY COURSE: This generally applies to business. It requires that (1) the underlying debt that was repaid during the preference period was incurred in the ordinary course of business or financial affairs between the parties; and (2) the repayment was made either in the ordinary course of business or financial affairs of the debtor and the transferee, OR, made according to ordinary business terms. For example, if payment is due within 30 days of an invoice according to the terms of the agreement between the parties, but is paid 50 days after, that can appear to be a preference. However, if during the entire course of the relationship between the debtor and creditor, the debtor always paid invoices between 45-60 days, properly proving that fact could be a valid defense.
We have the experience needed to properly assess the strength of the trustee’s preferential transfer claim and the legal defenses you have. Whether the best option in your case is to aggressively defend the suit or negotiate a settlement with the trustee, we will make sure you obtain the best possible outcome. Call Royzman Law Firm at 310.954.8503 or contact us online to schedule a consultation.
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