Avoiding the Bankruptcy Blues

By Thomas Repczynski | Dec 15, 2009




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Getting paid is a business survival issue for electrical contractors. Your customer’s bankruptcy impacts your ability to get paid. It also can result in a court undoing prior transactions if the court views them as preferences. You need to understand preferences and follow some basic tips to protect the health of your business.

A bankruptcy preference is a payment, not necessarily of money, made to a creditor within 90 days prior to a debtor entity’s bankruptcy filing. This period is much longer for company insiders. There are several important preference defenses, however, under the bankruptcy code.

1. Assume it’s a preference

Because a payment does not become a preference until the subsequent bankruptcy filing, one cannot know upon receipt whether the funds might eventually have to be paid back. This can sometimes be years later. If you are dealing with a company that has been showing signs of trouble, assume any payments received from it are potentially preferential and may be subject to an action to recover them. Run a 90-day clock for each payment. Account for the funds sensibly. If possible, establish appropriate reserves.

2. Keep accurate payment records

The first line of defense is payment history information. You need reliable documentation of key information including the date sent and received, payment method of each, and the terms applicable to each transaction. This will enable you to better assess your potential defense to a claim before one is even filed and improve your negotiating posture.

3. Think twice before changing terms

A payment received in the ordinary course of doing business is not preferential. Ordinariness can be measured either as between the two parties themselves or the industry as a whole. You should avoid any objective indicators that steps were taken by either of you to pay or require/allow payment sooner or later than normal because either will likely result in an indefensible preference claim as to the extraordinary payment(s). It will be easier to argue nonpreferential reasons for a scatter pattern of payments if there is no change in payment terms associated with the transaction history.

4. Think twice, but act in your own best interest

Bankruptcy may be inevitable. As long as you are not contractually bound to supply the debtor and/or accept payment on particular terms, consider demanding payment up front. If the would-be debtor paid money and received new value that is reasonably equivalent in return, as opposed to making payment on a prior obligation, this contemporaneous exchange for value is deemed by statute to be nonpreferential.

5. Assess the risk, and decide whether to keep doing the work

A trickier defense comes into play if you continue to do business with the company, but do not insist on cash on delivery. If a debtor makes a payment on antecedent debt, you are entitled to keep the payment even if the company later files for bankruptcy to the extent that you subsequently do more business with the debtor for which you are not paid prior to the company’s filing. All other things being equal, if a company pays you $1,000 for work you did last month and asks you to do another $1,000 worth of work, which you do the day before you are surprised by the news of the company’s bankruptcy and before you have even invoiced, you are entitled to keep the $1,000 you were paid because you provided the debtor with another $1,000 worth of value even though the two transactions were completely unrelated. This defense is factually complicated to establish but, if timed properly, may reduce substantially the amount you would otherwise have to pay back to the debtor.

When you learn of a bankruptcy filing, you should naturally undertake a preference analysis to assess your potential exposure and defenses. The overwhelming majority of preference cases are settled for a fraction of the original amount demanded. The more you know about your account history and the less you have to explain away payments that appear to be outside the normal dealings of the parties, the better the chances that you, not the debtor’s other creditors, will be holding the cash at the end of the day.

This article is not intended to provide specific legal advice, rather, as a general commentary regarding legal matters. You should consult with an attorney regarding your legal issues, as the advice will depend on your facts and the laws of your jurisdiction.

REPCZYNSKI is a shareholder in the law firm of Bean, Kinney & Korman in Arlington, Va. He can be reached at [email protected].

About The Author

Thomas Repczynski is a shareholder in the law firm of Bean, Kinney & Korman in Arlington, Va. He can be reached at [email protected].

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