Bankruptcy “Clawback” Provisions: Top 2 ways to limit your preference exposure.
Your company provides excellent service to a customer and, after a long and anxious wait, is eventually compensated for your efforts. Your customer proceeds to file bankruptcy, and you breathe a sigh of relief that you got paid before that happened. But then you receive a claim from the bankruptcy trustee, seeking the return of payments you received within 90 days of the bankruptcy filing.
Under bankruptcy law governing “preferences,” the debtor’s bankruptcy estate can recoup delinquent payments made within that 90-day window. The rationale for this law is that when the debtor paid you, it should instead have spread the funds it had available among all of its creditors, as opposed to preferring you. In alleging a preference, the trustee does not claim that your company erred in anyway. Instead, he merely seeks to recover the funds and distribute them in the way the law would consider more appropriate.
This may be the only area of law where a creditor can be forced to pay money despite the fact that no one even contends that the creditor did anything improper. Because this runs counter to what we normally expect from the law, preference claims are among the most frustrating for anyone whose business involves the extension of credit to customers – which is to say, just about any business.
Fortunately, not all payments received during the 90-day period preceding a bankruptcy constitute preferences subject to the clawback provisions. There are several defenses available, and with a proactive approach your company can limit its preference exposure in situations where your customer files for bankruptcy.
Here are the top 2 tips for protecting your company:
1. Monitor Your Accounts Receivable & Maintain Ordinary Course of Business
Payments received in the ordinary course of business are not considered preferences. If you receive payments timely, consistent with the industry norms, the payments cannot be clawed back in the bankruptcy. A proactive approach with your accounts receivable can help ensure that payments are received in this manner. If you allow accounts to become delinquent, you can lose this protection.
2. Require Contemporaneous Payments, Especially When Customers Are Showing Signs of Financial Struggles
If your see that a customer is struggling, you should require contemporaneous payment with the delivery of whatever goods or services you provide. The contemporaneous payment/exchange will protect the payment from a preference attack. This is a valuable tool to deal with problem customers.
At Marrs & Henry, we have substantial experience in advising clients about protecting themselves from preference attacks when payments from struggling customers arrive late. We also have experience defending these trustee suits when possible, and negotiating discounted settlements when appropriate. Because preference liabilities can be substantial and quite surprising, legal representation is essential whenever a client receives a demand letter or trustee’s suit.