Q: What is a "preference payment" and why do I care?
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Q: What is a "preference payment" and why do I care?
A: A "preference payment" is payment made by someone just prior to filing a bankruptcy, and it could mean that the bankruptcy court will force you to give it back!
Federal Bankruptcy laws allow a bankruptcy trustee (the office in charge of a bankruptcy estate) to recover payments made by the debtor within the 90 days before debtor's bankruptcy filing. If the recipient of the payment is an "insider" with the debtor (e.g., a relative, or officer of the debtor company), that time period is extended to one year before the filing of the bankruptcy. These types of payments are "preference payments."
The policy behind the preference payment laws is grounded in the fair and orderly distribution of a bankrupt debtor's estate. Bankruptcy seeks to prevent one creditor from getting its full amount owed, while another gets nothing. Rather, the law mandates that all assets in the bankruptcy estate will be marshaled and then distributed according to enumerated priorities (e.g., secured, then unsecured, etc.), and in pro rata amounts based on the debts owed.
What does this mean to you? Well, after the months of numerous e-mails and phone calls, you finally collect what you are owed from that one customer that you knew was having financial problems-and then a month or so later, the bankruptcy trustee sends you a letter demanding that payment back. Ouch!
As with any good law, there are exceptions. Two of the most common exceptions include the "contemporaneous exchange" and "ordinary course" payments exceptions.
Payments made by the debtor within the 90 days before the bankruptcy will not be returned if the payment was in exchange for contemporaneous value (as opposed to an old debt). This means that the bankruptcy estate got something for the payment. In addition, payments made (albeit sometime after getting something from the creditor) will stand if such "late" payments are consistent with the parties' established ordinary course of dealings. Thus, if you always gave the debtor 120-day terms, and that is when you got paid, you would have a good argument that the payment should not be returned to the bankruptcy estate.
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Other questions? Contact:
Daniel Kessler
BKCG Partner
949-975-7500
dkessler@bkcglaw.com