“Bankruptcy Preferences: Claims and Defenses (Part I)”

Bankruptcy Preferences:  Claims and Defenses (Part I) 

Quite often in a Chapter 7 bankruptcy case (often called a “straight” bankruptcy or a “liquidating” proceeding), or occasionally in a Chapter 11 or 13 proceeding, certain creditors may receive a demand letter (typically from a Trustee) demanding return of a certain sum of money (or occasionally property) as a putative preferential transfer, or  “preference”.  In most cases, the creditor is still owed money by the bankrupt person or entity (also called a “debtor”), and they are incredulous, baffled, indignant, and often angry, that a Trustee is demanding that they return monies to him when the debtor still owes them a bunch of money.  This article addresses such situations and is intended to help you understand the basis for a preference demand and what you can do to defend yourself when such a claim is made.

First of all, a preference, by definition,  is a payment or transfer that is made by the debtor to a creditor; on account of an antecedent (old) debt;  that is made on or within 90 days prior to the filing of a bankruptcy case (or made within 1 year before filing if the payment is to an insider – typically a close relative); made while the debtor was insolvent (liabilities exceed assets);  that enables such creditor to receive more than they would have received had such transfer not been made and they received a distribution under  the provisions of Chapter 7 of the Bankruptcy Code (the “greater distribution test”).  (In virtually every case, unless you have a 100% distribution, this last element is almost a given).

The whole theory of preferential transfers is based upon what is called “equality of distribution”; that is to say, similarly situated creditors should be treated the same.  This means that a debtor should not be able to favor or “prefer” one or more of his creditors (through such payments) over all of his other creditors, as this is not “fair”.  In order to help assure equal treatment of the creditors in a bankruptcy case, the duly appointed Trustee is given the power to set aside or avoid these transfers, if the above elements are met, and to recover the monies or property involved, through the powers he is given under the Bankruptcy Code.  The idea is to allow him to recover the payments that are preferential and then equally distribute such sums to all of the creditors in the case, per the distribution provisions of the Bankruptcy Code, and to not favor a select few creditors as chosen by the debtor.   

Typically, these matters first come to a head when a creditor receives a “nasty gram” from the Trustee; i.e. a demand letter giving the creditor so many days to return what the Trustee deems to be a preferential transfer.  The letter usually indicates that if the funds at issue are not returned to him by a certain date, the Trustee will be compelled to file a lawsuit in the Bankruptcy Court (called an “adversary proceeding”) to recover a judgment for the amounts in controversy and to, if necessary, take action to collect on such judgment.
If you receive such a letter, you should immediately contact a bankruptcy specialist, like the bankruptcy professionals at Damon, Ver Merris, Boyko & Witte, PLC, who deal in these matters on a regular basis.  There may be a variety of defenses available to you to thwart such claims and provide  partial or complete relief from liability.  If a lawsuit has been commenced, you typically have only 30 days from the date of service to file an answer to the complaint, so the need to act quickly is critically important in order to protect your rights and to make sure that a default judgment is not entered for the amount demanded for your failure to respond.

A number of statutory and case law driven defenses are usually available to most creditors.  These are called affirmative defenses and must be asserted (and proved) by the creditor who receives such a demand.  If you sit on your rights you may literally be throwing away thousands of dollars, may lose any claim you may have in the underlying bankruptcy case, as well as facing garnishments, executions against your property, and similar collection measures (talk about salt in the wound!).

In the next article, I will address the specific defenses that are typically available to most creditors and how such defenses may apply to your situation.  In the meantime, should you be facing a preference demand, need to file a proof of claim in a bankruptcy case, or just have questions about the bankruptcy process, contact the professionals at Damon, Ver Merris, Boyko, and Witte, PLC, at (616) 975-9951.  We can guide you through this complicated legal maze and help limit your exposure.   – Larry A. Ver Merris  /  February 19, 2018

While this posting originates from a law office, none of the contents should, in any way, be considered legal advice. If you have not signed a retention letter describing the legal services to be provided and the amount to be paid for such services, you are not a client of this firm.