When your customer files chapter 11 or 7, your first concern is “how much am I owed and will I be paid?” After determining your balance due and filing your proof of claim, you have another task. You may have more loss exposure in the bankruptcy due to “preference law.” 

You should examine your records to determine what transfers you received from the debtor within the 90 days prior to the bankruptcy filing.1 “Transfers” include all payments you received and any goods that were returned to you. In the case of payments you received, the “date of the transfer” is not the date on the check or the date you received it . . . it is the date the check cleared the debtor’s bank account. Under bankruptcy law, any transfer made by the debtor during the 90 days prior to filing may be a preference and potentially recoverable by the debtor or a trustee.

To further complicate your situation, there may be significant time between the bankruptcy filing and the filing of a preference suit against you. If you are not aware of your potential exposure, your records might be destroyed or lost and your ability to defend yourself can be diminished. Therefore, if you are a potential preference defendant, early awareness is important so you can gather and preserve information needed for your defense. Notes or correspondence with the debtor during and shortly prior to the 90 day preference period as well as documentation of the billing and payment history with the debtor within the year prior to the bankruptcy petition date could be critical to mounting a successful preference defense. 

It is important to know and understand the time frame within which a debtor or trustee may file a lawsuit to recover a preference. Section 546(a)(1)(A) of the Bankruptcy Code provides that a preference action must be commenced within 2 years after the entry of an Order for Relief against the debtor. The term “order for relief” refers to the initial filing date, and not to the date of any conversion to a different chapter. If a debtor files a petition on October 25, 2000, then the two year period will expire on October 25, 2002. However, if a trustee is appointed in the case, the trustee has at least one year to bring actions. Therefore, if a trustee is appointed within two years of the entry of the Order for Relief, for example on July, 15, 2002 under the above example, then the Code provides for an additional one year for the trustee to sue, making July 15, 2003 the new deadline for filing a preference action, nearly three years after your receipt of the payment.

It is very common for preference suits to be brought between 18-24 months after the bankruptcy filing . . . and in some circumstances up to 36 months later. When and if suit is brought, you must be prepared to promptly defend and you must have the necessary records available. Analysis of your potential exposure at the outset is therefore advisable. In situations where your auditors require reserves against potential liability, you may be able to minimize these reserves by having a preliminary evaluation of your exposure to determine what your ultimate liability will be. 

The time period the debtor or trustee has to file a suit is called the statute of limitations period. If time is running out on this period, the debtor or trustee might discuss with you a “tolling” of the statute of limitations to provide more time to discuss settlement. You may enter such an agreement but are not required to. If you do not, it is likely the suit will be filed against you to preserve the estate’s right to recover the preference. 

If you have questions regarding this publication, please contact Lisa Sumner at (919) 783-2869 or  lsumner@poynerspruill.com.

This electronic publication is published by Poyner & Spruill LLP to provide general information about significant legal developments. Because the facts in each situation vary, the legal precedents noted herein may not be applicable to individual circumstances.