Nearly all of our creditor clients have experienced the unpleasantness of receiving a demand from a bankruptcy debtor or trustee requiring that the creditor return monies it properly received on account of goods or services sold to the debtor. Generally, the preference to be disgorged is comprised of payments received by the creditor within the 90 days immediately prior to the debtor’s bankruptcy filing for which the creditor does not have one of the limited, bonafide defenses.
Well hold on to your hat! Now, in addition to the trustee or debtor-in-possession bringing an action to recover preferences, now the post-petition lenders will be demanding a lien on preference recoveries in order to further secure their post-petition financing position.
This development arises from the Qualitech Steel case, which came out of a bankruptcy court in Indiana in 2003. In that case, the bankruptcy court had agreed that pre-petition secured lenders who were otherwise unwilling to participate as post-petition financers could be given the first $30 million of any preferences recovered. This would protect the lender from any deterioration in their already undersecured position and would be consideration for their advancing the post-petition financing needed by the Chapter 11 debtor. The debtor needed the funding so it could remain in business until its assets could be sold as a going concern, thus yielding more for this same undersecured secured creditor which had a lien on all the debtor’s assets.
The lender’s representative, Mellon Bank, brought adversary proceedings to recover the alleged preferential transfers and the battle ensued. Creditors who were sued claimed that the recoveries were flowing directly into the pocket of the lender and were not “benefiting the estate.”
In the Bankruptcy Code, Section 550 specifically talks about preferences and says that the trustee (or debtor-in-possession) may recover, “for the benefit of the estate,” the property or funds which have been transferred. The preference defendants argued that requiring unsecured creditors to disgorge preferential payments into the pocket of the lender did not confer a “benefit on the estate.” The case went up to the Seventh Circuit Court of Appeals which supported the bankruptcy court’s position. The Seventh Circuit said that the estate had already obtained an indirect benefit from the transaction in that the secured lender had agreed to provide post-petition funding as a result of the grant of the preference recoveries. The case was then appealed to the United States Supreme Court. In a decision issued in 2004, the Supreme Court refused to review the decision thus leaving the Seventh Circuit opinion intact.
Many judges have historically refused to allow secured creditors to take a lien on preference recoveries. In light of this decision, unsecured creditors can expect that the demand for liens on proceeds of preference recoveries will be a common provision in many post-petition funding documents in the future. Until and unless the Supreme Court reexamines the situation or Congress clarifies it, you now have to deal not only with trustees and debtors-in-possession, but with greedy post-petition lenders who are after your preferential recovery and may be much less willing to negotiate.
Whenever you have a customer in difficulty, feel free to call for advice on how to structure payments or future dealings so as to minimize your exposure to preferences. We defend preferences in all bankruptcy courts nationwide.
If you have questions regarding
this publication, please contact Judy
Thompson at (704) 342-5255 or jdthompson@poynerspruill.com.
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