By Ronald A. Spinner and Steven A. Roach
About a year and a half ago, one of your business clients called. A customer of theirs filed for bankruptcy, and they wanted your guidance. You helped them file a Proof of Claim, noting that meaningful recovery was unlikely. You suggested the client review its records for any telltale signs that might help them identify problem cases like this one, for future preemptive action. Your client thanked you, happy to put the matter behind it.
Today, you received a call from your now anxious client. They just received a letter written on the bankrupt company’s behalf. The letter demanded that your client “return” a significant amount of money (much more than listed in its Proof of Claim) that the letter claimed your client had received in the 90 days prior to the debtor’s bankruptcy filing. The letter’s tone was almost apologetic. The letter stressed that the client did nothing wrong, but insisted that the debtor could still demand this money back, offering a slight “discount” for quick payment.
One thing was clear: if your client doesn’t pay soon, it will be sued. Your client is surprised and concerned (and a bit miffed). How can they do this? Can you help?
Your client just received a “preference demand.” This article discusses what that is, why debtors make them, and the two most common defenses used to minimize exposure to them.
“What the heck is a ‘preference?’”
The concept of “preference” dates back to old English law. Old English judges believed that debtors know when they are in trouble. When they are, debtors begin to choose which bills to pay and which to ignore. Aggressive or important creditors are paid “preferentially” over less critical ones, even though most have similar rights in an insolvency proceeding. Those paid will have received at least some funds when a bankruptcy case is eventually filed. The rest get little or nothing.
English judges thought this approach was unfair. They believed that all unsecured creditors who received funds from a debtor in the months prior to bankruptcy should pool the money received so that it can divided pro rata amongst them. This idea became enshrined in U.S. law, setting the 90-day window immediately prior to the bankruptcy filing as the lookback, or “preference,” period. U.S. law also provided creditors with defenses, so that they would continue to work with troubled companies rather than flee at the first sign of trouble.
The “demand letter” is the first step of the process, seeking return of funds a creditor received from the debtor.
“So, what do I do when my client gets a letter like this?”
First, don’t panic! The defenses discussed here (and others) usually can mitigate the demand, and usually by more than the typical 5-25% discount a trustee may offer for quick payment. The two most used defenses are “subsequent new value” and “subjective ordinary course.”
“Subsequent new value” is usually the harder of these two for a trustee to challenge, though the defense is limited in scope. Its concept is simple: if a debtor makes a payment to a creditor, and the creditor subsequently delivers goods or services to the debtor worth as much or more than the payment, then the debtor ends up no worse off. The “new value” provided by the creditor “subsequent” to the payment replenishes the debtor’s estate. Of course, only subsequent replenishment counts, and the estate must truly benefit from these goods and services for this to apply. For instance, if goods provided are subject to an unavoidable lien, they won’t count for this defense.
The other common defense is the “subjective ordinary course of business" defense. This defense applies if a creditor’s transactions with the debtor during the preference period are very similar to those prior to the preference period.
If the creditor did not suddenly change payment terms or start calling the debtor repeatedly for payment, and if the debtor did not suddenly start paying more slowly or quickly than before, then this defense might shield some of the debtor’s payments from recovery.
Of course, showing that transactions were “ordinary” usually requires a bit of statistical analysis, but a good preference defense attorney can handle that.
Attorneys who know the technical details of how these two defenses work can combine them, yielding greater savings.
The bottom line? Preferences usually can be resolved, often without litigation
There are other defenses, of course, but suffice here to say that most preferences can be mitigated, at least to some extent.
The best thing you can do when your client receives a demand letter like this is to connect them with a reputable preference attorney. The preference attorney can help them determine what their defenses are and what their exposure might be. A good preference defense attorney will attempt to resolve the demand through negotiation, rather than litigation, to minimize expenses. Most trustees are amenable to (and, pun intended), “prefer” such an approach.
Sooner or later, most companies get one of these letters. The good news is that these demands can be resolved, often for far less than is demanded. While no one “prefers” to get one of these letters, it is good to know that these letters usually are not as threatening as they initially appear.
Ronald A. Spinner is a principal at Miller Canfield whose practice focuses on bankruptcy, restructuring and insolvency, including creditor representation, distressed transactions, loan enforcement and related matters. He is known for developing practical, results-oriented strategies in complex matters, including novel issues involving Chapter 9 proceedings, preference defense and cryptocurrency in bankruptcy.
Steven A. Roach is a principal at Miller Canfield with 40 years of experience in commercial transactions, loan enforcement, restructuring and insolvency matters. He represents financial institutions, secured lenders and other clients in workouts, receiverships, bankruptcy-related disputes and complex commercial litigation.
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Reprinted with permission from the Washtenaw County Bar Association newsletter Res Ipsa Loquitur.
About a year and a half ago, one of your business clients called. A customer of theirs filed for bankruptcy, and they wanted your guidance. You helped them file a Proof of Claim, noting that meaningful recovery was unlikely. You suggested the client review its records for any telltale signs that might help them identify problem cases like this one, for future preemptive action. Your client thanked you, happy to put the matter behind it.
Today, you received a call from your now anxious client. They just received a letter written on the bankrupt company’s behalf. The letter demanded that your client “return” a significant amount of money (much more than listed in its Proof of Claim) that the letter claimed your client had received in the 90 days prior to the debtor’s bankruptcy filing. The letter’s tone was almost apologetic. The letter stressed that the client did nothing wrong, but insisted that the debtor could still demand this money back, offering a slight “discount” for quick payment.
One thing was clear: if your client doesn’t pay soon, it will be sued. Your client is surprised and concerned (and a bit miffed). How can they do this? Can you help?
Your client just received a “preference demand.” This article discusses what that is, why debtors make them, and the two most common defenses used to minimize exposure to them.
“What the heck is a ‘preference?’”
The concept of “preference” dates back to old English law. Old English judges believed that debtors know when they are in trouble. When they are, debtors begin to choose which bills to pay and which to ignore. Aggressive or important creditors are paid “preferentially” over less critical ones, even though most have similar rights in an insolvency proceeding. Those paid will have received at least some funds when a bankruptcy case is eventually filed. The rest get little or nothing.
English judges thought this approach was unfair. They believed that all unsecured creditors who received funds from a debtor in the months prior to bankruptcy should pool the money received so that it can divided pro rata amongst them. This idea became enshrined in U.S. law, setting the 90-day window immediately prior to the bankruptcy filing as the lookback, or “preference,” period. U.S. law also provided creditors with defenses, so that they would continue to work with troubled companies rather than flee at the first sign of trouble.
The “demand letter” is the first step of the process, seeking return of funds a creditor received from the debtor.
“So, what do I do when my client gets a letter like this?”
First, don’t panic! The defenses discussed here (and others) usually can mitigate the demand, and usually by more than the typical 5-25% discount a trustee may offer for quick payment. The two most used defenses are “subsequent new value” and “subjective ordinary course.”
“Subsequent new value” is usually the harder of these two for a trustee to challenge, though the defense is limited in scope. Its concept is simple: if a debtor makes a payment to a creditor, and the creditor subsequently delivers goods or services to the debtor worth as much or more than the payment, then the debtor ends up no worse off. The “new value” provided by the creditor “subsequent” to the payment replenishes the debtor’s estate. Of course, only subsequent replenishment counts, and the estate must truly benefit from these goods and services for this to apply. For instance, if goods provided are subject to an unavoidable lien, they won’t count for this defense.
The other common defense is the “subjective ordinary course of business" defense. This defense applies if a creditor’s transactions with the debtor during the preference period are very similar to those prior to the preference period.
If the creditor did not suddenly change payment terms or start calling the debtor repeatedly for payment, and if the debtor did not suddenly start paying more slowly or quickly than before, then this defense might shield some of the debtor’s payments from recovery.
Of course, showing that transactions were “ordinary” usually requires a bit of statistical analysis, but a good preference defense attorney can handle that.
Attorneys who know the technical details of how these two defenses work can combine them, yielding greater savings.
The bottom line? Preferences usually can be resolved, often without litigation
There are other defenses, of course, but suffice here to say that most preferences can be mitigated, at least to some extent.
The best thing you can do when your client receives a demand letter like this is to connect them with a reputable preference attorney. The preference attorney can help them determine what their defenses are and what their exposure might be. A good preference defense attorney will attempt to resolve the demand through negotiation, rather than litigation, to minimize expenses. Most trustees are amenable to (and, pun intended), “prefer” such an approach.
Sooner or later, most companies get one of these letters. The good news is that these demands can be resolved, often for far less than is demanded. While no one “prefers” to get one of these letters, it is good to know that these letters usually are not as threatening as they initially appear.
Ronald A. Spinner is a principal at Miller Canfield whose practice focuses on bankruptcy, restructuring and insolvency, including creditor representation, distressed transactions, loan enforcement and related matters. He is known for developing practical, results-oriented strategies in complex matters, including novel issues involving Chapter 9 proceedings, preference defense and cryptocurrency in bankruptcy.
Steven A. Roach is a principal at Miller Canfield with 40 years of experience in commercial transactions, loan enforcement, restructuring and insolvency matters. He represents financial institutions, secured lenders and other clients in workouts, receiverships, bankruptcy-related disputes and complex commercial litigation.
–––
Reprinted with permission from the Washtenaw County Bar Association newsletter Res Ipsa Loquitur.
