Magazine article Business Credit

Five Good-But Often Overlooked-Preference Defenses

Magazine article Business Credit

Five Good-But Often Overlooked-Preference Defenses

Article excerpt

THERE ARE FEW THINGS, IF ANY, THAT RAISE THE ire of credit professionals more than preference lawsuits. One of the most common complaints is the time associated with preparing an ordinary course or new value defense. Retrieving old invoices, checks, and related documents can be tedious and time consuming. Although the ordinary course and new value defenses will probably continue to be significant, there are other--often overlooked--defenses. The following defenses are particularly helpful because they will not require you to spend time retrieving and reviewing hard-to-find invoices and checks.

Distribution To Unsecured Creditors

The beauty of this defense is that it should help reduce preference exposure in any preference case where there is an anticipated distribution to unsecured creditors in the underlying bankruptcy case. As background, if a defendant loses a preference lawsuit, it is entitled to an unsecured claim for the amount it is required to pay. This makes sense given that it is not disputed that the debtor owed' the creditor the money in the first place! Therefore, to determine a preference defendant's net preference exposure, there should be a reduction for the amount of the projected distribution to unsecured creditors.

For example, assuming that, after applying all applicable defenses, a preference defendant has preference liability of $100,000. If there is a projected distribution to unsecured creditors of $0.60 on the dollar, the preference defendant should take the position it should only have to pay $40,000 in settlement. The reason is that, if the preference defendant is ordered to pay $100,000 and if there is a distribution to unsecured creditors of $0.60 on the dollar, the preference defendant will receive a distribution of $60,000. (1) Rather than requiring preference defendants to jump through these hoops (i.e., paying $100,000 and then receiving $60,000), if the preference defendant will waive its unsecured claim, many trustees (2) will simply agree to reduce the preference exposure based on the anticipated distribution.

Preference defendants, however, should be careful when negotiating the waiver of their unsecured claim with the trustee. Trustees are usually in a better position than preference defendants to estimate the amount of the distribution to unsecured creditors. Therefore, if a sufficient amount of money is at stake, before waiving an unsecured claim, a preference defendant should conduct due diligence on the amount of the distribution to unsecured creditors.

Consider the following ways to conduct due diligence on the projected distribution in a Chapter 11 case. First, if a plan has been filed, review the disclosure statement. Often disclosure statements will contain a discussion of the projected distribution. Second, ask counsel for the unsecured creditors' committee. It may be difficult for them not to respond given the recent disclosure obligations placed upon creditors' committees by the recent bankruptcy amendments.

Payments Made With A Credit Card

If the debtor made the alleged preference payment using a credit card, the payment may not count as a preference. In a recent decision, Loverbridge v. The Ark of Little Cottonwood, Inc. (In re Perry), the United States Bankruptcy Court for the District of Utah ruled that a debtor's payment with a credit card did not constitute a preference. The court based its ruling on its conclusion that the debtor's credit was not "property of the estate," which is required for a payment to constitute a preference. For cases involving credit card payments, the decision should be very helpful in negotiations and--if push comes to shove--in litigation.

It may be premature, however, to go to the next step. The natural temptation is to require all customers to start making credit card payments when they get into financial distress. Given that the decision is not published in the official bankruptcy reporter and that there are cases where courts have ruled the other way in arguably analogous situations, this may be a risky move. …

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