Frequently Asked Questions (FAQ)

The term “creditor” is used to describe a company that has sold its goods or services to another company on credit terms. In other words, a creditor is an entity/entities or individual(s) that are owed money by a company that files bankruptcy.

Scheduling Order is an order issued by the Court providing information on the case deadlines; limiting the time to join other parties, amending the pleadings, completing discovery, and filing motions. The scheduling order is generally issued under Rules 26(a) and 26(e)(1)

Nothing. Both are a form of open account terms.

Reclamation is the right of a seller to recover possession of goods delivered to an insolvent buyer. The remedy of reclamation is needed when an unsecured vendor is unable to retrieve goods or stop them in transit. A reclaiming vendor need not prove fraud, although the premise of reclamation is that the vendor was defrauded.

Summary judgment is a determination made by a court without a full trial. Such a judgment may be issued as to the merits of an entire case, or of specific issues in that case. A Motion for Summary Judgment is a request made by a defendant in a civil case to promptly and expeditiously dispose of a case without a trial. It is used when there is no dispute as to the material facts of the case and a party is entitled to a Judgment as a Matter of Law.

Adversary proceedings are lawsuits brought by interested parties in the bankruptcy process, and are initiated by filing a formal complaint with the bankruptcy court. These proceedings are governed by the Federal Rules of Bankruptcy Procedure. The adversary complaint is served on the individual who is the subject of the proceeding. After an individual who is served with the adversary complaint files an answer, a bankruptcy court schedules a hearing before a judge, who then settles the matter in dispute. Often an adversary proceeding is used to resolve competing claims between a debtor’s various creditors. A complaint in a bankruptcy case can be filed by either the debtor, the creditors of the debtor, or a bankruptcy trustee.

A Motion to Dismiss is a written submission to a court at a preliminary stage of any case, generally before a defendant answers, seeking dismissal of the case on one of several grounds, including lack of jurisdiction over the
person or subject matter, failure of the plaintiff to allege necessary elements of the cause of action asserted in the complaint, etc.

Interrogatories (also known as requests for further information) are a formal set of written questions propounded by one litigant and are required to be answered by an opposing party to clarify matters of fact. This also helps to determine in advance the facts which could be presented during a trial. Requests for interrogatories are a part of discovery process in a civil case. In the U.S. federal court system, they are governed by Rule 36ofthe Federal Rules of Civil Procedure.

Lien avoidance is the process through which a debtor who is filing for bankruptcy can avoid certain liens that may be attached to the exempt property of the debtor prior to filing a bankruptcy petition. This action is often used to clear title to land from a judgment lien arising out of pre-petition activity in a state court. The debtor accomplishes this by way of a Motion to Avoid Lien. This process essentially turns a secured lien on a property into an unsecured lien, thereby avoiding any security interest. In order to do this, the lien must be a non-purchase money loan, in which the debtor pledges property he or she already owns as collateral for the loan. Examples of this include home equity loans or credit union loans on a car. The collateral attached to the loan must also be able to be classified as exempt, and be part of the debtor’s exempted estate.

A “count” is just a way to organize allegations in a lawsuit. In a well organized complaint, each count is based on a distinct legal theory that allows a plaintiff to make a claim against a defendant.

Section 502(d) requires a bankruptcy court to disallow any claim under Section 501 (claims for which one has filed or are deemed to have filed a proof of claim) unless any preference payments are first repaid. At times, the debtors and trustee use Section 502(d) to delay, defeat or reduce creditor rights to administrative expenses under Section 503.

Request for admissions (sometimes also called a request to admit) are a set of statements sent from one litigant to an opposing party, for the purpose of having another admit or deny the statements or allegations. Requests for admissions are part of discovery process in a civil case. In the U.S. Federal Court system, they are governed by Rule 33 of the Federal Rules of Civil Procedure.

502(h) claim is a provision entitling an unsecured claim to a creditor for an amount that such creditor paid to a trustee/debtor in the settlement of an avoidance action. Accordingly, it is important that a creditor have its bankruptcy counsel carefully review any proposed settlement agreement in order to ensure that a claimant does not inadvertently waive its pre-petition claim or its Sec.502 (h) claim in connection with the settlement of an avoidance action.

A secured creditor is a creditor who has security interest over some or all of the assets of a debtor. A secured creditor is one who has sold its goods and/or services, or loaned money on the basis of collateral pledged to secure the debt or who has filed a lien on property of the debtor. Banks and other lending institutions are generally secured creditors. In the event of the bankruptcy of a debtor, the secured creditor can enforce their security against the assets of the debtor, and avoid competing for a distribution on liquidation together with the unsecured creditors.

The critical vendor doctrine applies to the vendors that are so vital to the continued business operations of a debtor that their refusal to sell to the debtor could mean the demise of the debtor and its reorganization. In such cases, the debtor may request a court to authorize the debtor to make immediate payment of the vendor’s pre-petition claim, in exchange for a commitment by the vendor to sell to the debtor on a post-petition basis under the same or better terms. This arrangement elevates critical vendors’ otherwise low-priority pre-petition unsecured claim to a higher priority administrative claim, ensuring payment in full if the debtor successfully reorganizes.

A plan or reorganization is a document setting forth how a bankrupt company plans to satisfy its creditors. The plan of reorganization is the cornerstone of a successful Chapter 11 bankruptcy. The bankrupt company generally has 120 days following the filing of petition to present a plan of reorganization to the court. Bankruptcy judges however, may extend the time in which a plan can be submitted and approved.

A Debtor in Possession, commonly referred to as a DIP, is a person or corporation who has filed a bankruptcy petition, but remains in possession of property upon which a creditor has a lien or similar security interest. The debtor remains in control of the operations of a bankrupt company. Generally, a debtor in possession is the debtor in Chapter 11 proceedings. Trustees however, may in some cases operate a bankrupt company instead of the original management that drove it into bankruptcy.

A group representing firms that have claims on a company facing bankruptcy or extreme financial difficulty is referred to as “creditors” committee.In other words, a creditors’ committee is a committee of representatives of creditors appointed by the U.S. Trustee. The committee acts on behalf of all creditors of the bankrupt company in negotiating a plan of reorganization and other major actions.

A voluntary bankruptcy is one in which a debtor files the petition on its own volition.

An involuntary bankruptcy is one that is initiated by at least 3 creditors holding unsecured claims aggregating at least $5,000 or more against a debtor.

A bankruptcy becomes effective as of the date a petition is filed and recorded with a bankruptcy clerk.

A proof of claim is a form filed with a bankruptcy court by a creditor setting out its claim against bankruptcy debtor. In other words, it is a document a creditor files with a court to prove that the debtor owes them a debt.

An expert witness is a witness, who by virtue of education, training, skill or experience, is believed to have expertise and specialized knowledge in a particular subject beyond that of the average person, sufficient that others may officially and legally rely upon the witness’s specialized (scientific, technical or other) opinion about an evidence or fact issue within the scope of his expertise, referred to as the expert opinion, as an assistance to the fact-finder. An expert witness is retained to assist attorneys in the defense of preference claims filed against creditors.

A mechanic’s lien is a security interest in the title to property for the benefit of those who have supplied labor or materials that improve the property. The lien exists for both real property and personal property.

Antecedent debt means pre-existing debt. If a payment on antecedent debt is made by a debtor to a creditor during the preference period (i.e. within 90 days of the bankruptcy filing), the transfer may be avoided by the court and returned to the debtor’s estate. Theoretically, the preferential transfer is returned to the debtor’s estate to enable an equal distribution for unsecured creditors.

A Trustee is an agent of the U.S. Department of Justice appointed to assist in the administration of bankruptcy cases. A Chapter 7 trustee liquidates non-exempt property and distributes it according to the scheme of priorities in the Code; the trustee also considers whether there are preferences or fraudulent transfers that can be recovered from which creditors can be paid. The trustee may bring a motion to dismiss the case as an abuse of the bankruptcy system or to deny the debtor a discharge if the trustee finds evidence of fraud, perjury, or ineligibility. A Chapter 13 trustee reviews the debtor’s plan and collects and distributes payments made by the Chapter 13 debtor. A debtor in possession is the debtor in a Chapter 11 proceedings; the ͞DIP͟ has the powers of the trustee under the Code and the responsibility to act as a fiduciary for creditors.

In a Chapter 7, a trustee is named on the notice of the first meeting of creditors which is sent to every listed creditor. This information is also available in the case file at the bankruptcy court, and over the phone in some districts. In most Chapter 11 cases, there is no trustee; the debtor assumes the duties of a trustee. The United States Trustee (UST) is different from the case trustee: UST’s are employees of the Department of Justice and have oversight, but not day to day operating responsibilities, in bankruptcy cases.

A Position Statement is a document which litigating parties often exchange to resolve the matter before trial. As evident from name, a Position Statement is drafted to represent the position of a case. It asserts the facts, alleged defenses, contentions, applicable statutes and precedents upon which a party relies and intends to base its case and argue/negotiate/settle accordingly.

Bankruptcy is a legal proceeding where a person or company who is having difficulty meeting financial obligations can obtain a fresh start. The right to file for bankruptcy is provided by a federal law, and all bankruptcy proceedings are handled in a federal bankruptcy court. Creditors may file a bankruptcy petition against a debtor (‘involuntary bankruptcy’) in an effort to recoup a portion of what they are owed or initiate a restructuring. In the majority of cases, however, bankruptcy is initiated by a debtor (‘a voluntary bankruptcy that is filled by the insolvent individual or organization’). Filing bankruptcy generally stops most creditors from seeking to collect debts. The goal of most debtors is to obtain a discharge order from the bankruptcy judge. The discharge order has the effect of releasing the debtor from many forms of debt that were incurred prior to the bankruptcy filing.

Yes. The most common types of bankruptcy allowed under the Bankruptcy Act are Chapter 7, Chapter 11 and Chapter 13.

A Chapter 7 bankruptcy is a liquidation proceeding. In a Chapter 7 bankruptcy, a court appoints a trustee to liquidate a company’s assets and to pay creditors with the proceeds of the liquidation.

A Chapter 11 bankruptcy allows a company to reorganize while continuing to conduct business. When a company files Chapter 11 bankruptcy, all creditors are stayed from collecting debts outstanding at the time of filing.

The Bankruptcy Act defines ͞insolvent͟as not being able to pay all your debts as and when they become due and payable. The bankrupt must have been insolvent at the time of the transfer or payment. The reasoning is that a solvent person has the capability of paying all of their debts, whether they actually did or not and therefore no creditor could have been advantaged over the others by receiving a payment.

The burden of proving insolvency lies with the trustee.

Preference defendants who do not file proofs of claim in the main bankruptcy case have the option to demand a trial by jury in the preference lawsuit. This is a right protected by the Seventh Amendment to the Constitution. The parties in a lawsuit can consent to have a bankruptcy court conduct jury trial but this doesn’t happen very often. A preference defendant makes a jury demand for three common reasons: o1. The defendant believes a jury would be more inclined to find in its favor than a bankruptcy judge;
o2. The defendant wants the case moved to federal district court from the bankruptcy court, which some defendants perceive as more debtor-friendly; and o3. Jury trials are more expensive and complex; the preference defendant can hope that will translate into settlement leverage.

The timing of preference claims is affected by 3 major factors: (1) the Statute of Limitations; (2) the desire of the debtor tore-establish goodwill (and trade credit) with the supply base; and (3) the discontinuation of the debtor’s business operations The Statute of Limitations period for bringing preference actions is often quoted as being 2 years from the date of the filing of the bankruptcy. Actually, the calculation of the Statute of Limitations is more complicated and an experienced attorney must be consulted to determine this.

Adversary proceedings and the original bankruptcy cases are separate but still ‘Associated’ Cases. A complaint to recover bankruptcy preferences is a lawsuit separate from the original bankruptcy case. It will have its own case number. It will have its own named plaintiff and a named defendant. Only a complaint will appear in the original bankruptcy case docket. After that, the adversary proceeding will have its own, separate docket. Although an adversary proceeding is a separate case, it is referred to as an ‘associate case’ of the original bankruptcy case.

The members of the Creditors Committee are selected by the United States Trustee assigned to the particular bankruptcy. The Creditors Committee is charged with representing the interests of the unsecured bankruptcy creditors as a whole. It is not representing the interests of any one creditor or even one particular grouping of creditors. The creditors committee can be both an advocate and an adversary for any single bankruptcy creditor. The creditor’s committee functions can be grouped into three categories: evaluation and investigation, advocacy and prosecution.

It depends upon the nature of the transactions. The Bankruptcy Code provides several defenses to a preference claim. Please consult an experienced attorney to identify the possible defenses available in your case.

A secured creditor is a person or business that loaned money on the condition that if the borrower failed to repay the debt they had a right to one (or some) of the borrower’s possessions. Loans secured in this way are known as secured debts. In simple words, this means when the borrower gets a secured loan, the borrower promises that if the borrower does not pay what he/she owes, the creditor can take a physical thing of value from the borrower to help repay the original debt.

Secured creditors possess specific legal rights which allow them to take the ownership of an asset back, should the debtor default on the corresponding security agreement. Some examples of secured creditors would be: (1) The financial institution that holds your mortgage (if you don’t make your payments then the creditor may take possession of and sell your house); (2) The financial institution that holds your car loan; (3) A leasing company; (4) A rent-to-own company; (5) A finance company; and (6) Any other creditor that you pledge your possessions to in order to receive credit.

Yes, there are Mechanic’s liens for creditors who have done work to a vehicle or property and governmental tax liens. Also, courts can grant any creditor an attachment pending a trial or an execution after a judgment has been awarded. When recorded properly at the registry of deeds, these vest secured rights in the creditor which may give a creditor even more rights than a mortgage holder.

Either the debtor pays them voluntarily or by a court order. Even unsecured creditors may gain secured rights through the courts.

Debtors may give payment preference to creditors with a perfected security interest, creditors holding their personal guaranty, and creditors that make or distribute a proprietary product or a product in high demand.

If you sell goods to a customer who is insolvent or who has very recently filed for bankruptcy, you may have the right to stop goods in transit or reclaim goods recently received by the insolvent customer that remain unsold. Your ability to exercise these ͞reclamation right͟ requires prompt action on your part. This is a very factually driven and detail-oriented process, and you should immediately call counsel to discuss the facts of the customer’s insolvency or bankruptcy.

It may be possible that the unsecured creditors have likely invoked the Necessity of Payment Doctrine, also called the Rule of Necessity, and been designated Critical Vendors. Critical Vendors are unsecured creditors who provide goods and services that are critical to the bankrupt business getting back on its feet. Therefore, the courts may look first at which creditors are essential to the bankrupt’s business. They get paid first to avoid a disruption in service. Other creditors with greater or equal priority interest just have to wait in line and hope there is something left over for them. Therefore, it is crucial to keep tabs on bankruptcy proceedings from the start in order to protect your interests.

How does this relate to a preference payment?A fraudulent transfer involves the sale or transfer of property made by a debtor with intent to defraud creditors or for which the debtor received less than the transferred property’s value. A preference payment is payment made to a creditor in the 90-day period before a debtor files bankruptcy (or within one year if the creditor in question was an insider) that results in that creditor receiving more than the creditor would have received in the bankruptcy case. Preferential transfers may or may not be fraudulent.

Yes. A Bar Date is a deadline for filing a Proof of Claim. The Bar Date is set by Court order. If you do not file a Proof of Claim by the Bar Date, you will be barred from asserting your potential claim against a debtor.

No.As a routine part of the Chapter 11 process, the Debtors must mail the Bar Date Notice to all known and potential creditors, including current and former vendors and employees who may have done business with the company before the filing. Receiving a Bar Date Notice does not necessarily mean you are owed money. In addition, you do not necessarily have a right to payment just because you received the Bar Date Notice and Proof of Claim form.

Yes. Bankruptcy proceedings can be long and drawn-out, thereby causing major problems for both the debtors and the creditors. Meanwhile, there is another option for recouping the missing funds: Some companies make a practice of buying out bankruptcy debt and giving creditors cash on the spot in exchange for their claims, although at a discount. This option is best fitted for those who are in desperate need of money and can’t afford to wait for another company’s bankruptcy proceedings to finish. The benefit of selling a bankruptcy claim is that, a seller gets a certain percentage of it upfront, regardless of how the bankruptcy ends up progressing. On the other hand, if one can wait to let the bankruptcy process take its course, then it might be worth to wait for a payout from the actual debtor. After all, the types of companies that purchase bankruptcy debt don’t do so for charitable purposes. They, too, are looking to make money by buying a claim at a significant discount and reaping the benefits of a larger payout down the line. There may be possibility that by selling one’s bankruptcy claim up front, one might therefore end up short-changing himself by not waiting for an official reorganization payout.

Yes. These include the following circumstances: 1.If the debtor committed fraud or used false or deceptive conduct; 2.If the debtor deliberately injured you or your property; 3. Injury or death caused by drunk driving; 4. Child support, maintenance or alimony obligations; 5. Other debts contained in a divorce or separation decree may be non-dischargeable, under certain circumstances; 6. Some governmental debts cannot be discharged, such as most student loans, some kinds of taxes, and credit cards / loans which were used to pay taxes. This might affect you if you have co-signed on such debts.

If you have a valid lien against the debtor’s property (home, car, personal property, etc.), you may still have valid rights against that property, even after a debtor has filed bankruptcy. But see an attorney before taking any action against the debtor or the property.

If the debtor has to pay money or turn over assets to the court, you may be able to collect a share by filing a Proof of Claim form with the Bankruptcy Court. The official Court notice will tell you whether you may file a claim, and the deadline for filing a claim. If you do not receive a claim form, these are available at the Bankruptcy Court Clerk’s office.

First, you must stop all collection against the debtor who has filed for bankruptcy. The notice is actually an order from the federal bankruptcy court which prohibits any kind of collection. If you already have an attorney representing you against the debtor, notify your attorney immediately. Second, you may wish to see an attorney to discuss your legal rights. But note that there are strict deadlines by which you must take certain actions, so see an attorney as soon as possible. Your attorney will review the case to see whether you have a good case against the debtor, and whether it is worth the time and cost. Finally, if you learn a person who owes you has filed bankruptcy, but don’t get a notice, you should still contact an attorney to protect your legal rights. Also, see an attorney if you didn’t learn about the bankruptcy until a deadline has passed – it is possible you may still have legal rights.

The notice from the Bankruptcy Court means that someone has identified you as a ‘creditor’. In other words, the person or company believes it owes you money, or might owe you money. The person or company who files bankruptcy is known as the debtor.

Preferences are payments or other transfers made within 90 days prior to a bankruptcy filing, on account of anantecedent or pre-existing debt, at a time when the debtor was insolvent, that allow the transferee to be ‘preferred’ by recovering more than it would have recovered had the transfer not been made and the defendant instead had simply filed a proof of claim for the amount involved. If a preference payment was made to an insider, the preference period is 1 year prior to the petition date. Preference payments are subject to recovery and returned to the bankruptcy estate. The trustee can demand that return of transfers received within 90 days (or 1 year) prior to someone’s bankruptcy filing. Any payment received is shared proportionally, with other creditors.

A ‘preference’ payment͟is any payment or transfer of value that a debtor makes to you inthe90-day period before the debtor files for bankruptcy that is made in connection with a pre-existing debt. The idea is to prevent debtors from skirting the bankruptcy process, to deter creditors from getting benefitted from available asset at the expense of other creditors, and to give power to trustee to recover monies or assets in order to make an equitable distribution to all the creditors. Otherwise, a debtor could transfer all of its assets to one creditor, then file for bankruptcy and leave all the other creditors with nothing. So, the bankruptcy code allows the trustee representing a debtor’s estate to reach back 90 days prior to the bankruptcy filing and recover any preferential payments.

What if I have missed the deadline?Most of the time you must respond within a certain amount of time or else you will default. The rules of civil procedure provide all the deadlines you need to know in your case. For example, under the federal rules of civil procedure, a plaintiff must serve a summons on the defendant within 120 days of filing the complaint, and the defendant in turn must, generally, file an answer with the court within 25 days of receiving the complaint. The time requirements may vary depending on what state you are in, or if you are in federal court.

A preference claim is an adversary action initiated by a trustee or an unsecured creditors’ committee on behalf of the bankruptcy estate of the debtor for the recovery of a preference payment.

Before the court avoids payment or transfer, it must be satisfied that: 1. A transfer of property was made; something passed from a bankrupt to a creditor; AND 2.It occurred at a time when the bankrupt was insolvent; AND 3.It occurred within the relevant time period before the bankruptcy; AND 4.The transaction gave the creditor an advantage over other creditors (usually determined as the creditor receiving more than they would have if they had proved for that debt in the estate).

If you fail to respond to the claim within time, the claimant can ask the court to enter default judgment against you just by lodging an application. This means asking the court to decide that you owe the money which has been claimed by the debtor.

The best way is to avoid the preference payments and reduce the risk of preference liability by taking certain proactive measures. Some of the measures include: business should stop taking credit and instead require advance payment or COD. Alternatively, if the business must have credit terms to accommodate its customers, then it should strive to maintain consistency. If the parties have agreed to certain arrangements, then the business should stick to them as much as possible. The other possible measure could be to have the terms of business consistent with the terms of others in the similar industry. Also, when the purchaser is late with its payments, a business should not engage in collection measures that are unusual compared to the practices of its other customers or the general industry practice. Payments resulting from such collection activity are more difficult to protect from preference liability. In addition, a business should maintain meticulous records of all transactions with its customers because thorough and complete records are crucial for establishing defenses against preference claims.

The Bankruptcy Code permits the trustee to avoid and recover from creditors payments made within the 90-day period before the bankruptcy filing. A ‘preference’ is defined by Section 547ofthe Bankruptcy Code as: (1) Payment on an ‘antecedent’ (meaning a previously incurred as opposed to current) debt; (2) Made while the debtor was insolvent (meaning its assets are less than its liabilities); (3) To a non- insider creditor, within 90 days of the filing of the bankruptcy; (4) That allows the creditor to receive more on its claim than it would have, had the payment not been made and the claim paid through the bankruptcy proceeding. Section 550 of the Bankruptcy Code allows the trustee to avoid and recover any preference payments by filing a lawsuit against the creditor. Typically, a preference action is often preceded by a ͞demand letter͟from the debtor or the trustee. The demand letter sets forth the trustee’s claims and demands immediate payment. Most of the times, the trustee is willing to settle the preference action for an extremely reduced amount if the settlement is reached before the lawsuit is filed. Consequently, when the creditor receives a ͞preference demand letter,͟the creditor should always have experienced bankruptcy counsel review the case to determine whether the creditor has valid defenses. Bankruptcy counsel can often negotiate a favorable settlement and allow the creditor to avoid having to expend large sums of money in litigation. If the parties do not reach a settlement, the preference action is initiated with a complaint filed with a bankruptcy court. The preference complaint is similar to any other lawsuit with the exception that it is filed in a bankruptcy court, rather than federal district or state court.

Yes. The transaction must have involved or been done at the direction of a creditor of the bankrupt, and must have satisfied a debt that would have been provable in the estate if the transaction had not been done.

Yes. There must have been a transfer of some property between the parties. It is common for that transfer to be a payment of money, but any asset passing from the bankrupt to the creditor will be sufficient to be a transfer of property.

Yes. A preference cannot be given to a creditor holding a security over assets. Secured creditors either give up their security (if the creditor is paid in full), or the bankrupt gains equity in the secured asset (if the creditor is not paid in full). But if the security was not properly created or the value of the security is less than the amount of the payment, the transfer or part of it may be preferential.

The creditor must have received more than he would have received if the case were a Chapter 7 liquidation case, the transfer had not been made, and the creditor received payment of the debt provided by the provisions of the Code or if creditor had refunded the monies and proved for that amount in the bankruptcy. This is a purely mathematical calculation. If the creditor did not receive more by way of the payment than they would have received from a dividend in the bankruptcy, there is no advantage or preferential treatment.

What time period is relevant for preference claim?Section 546(a) of the Bankruptcy Code has a two part test for determining the time limit for bringing bankruptcy preference actions. Bankruptcy preference claims are time barred after the later of (1) 2 years after the bankruptcy filing or (2) 1 year after the appointment of a trustee. Under this calculation, if a trustee is appointed in the second year of a bankruptcy, it will have a full year to decide whether to bring preference claims. Because most trustees are appointed within the first year of a bankruptcy filing, as a general rule of thumb, 2 years from the date of filing of the bankruptcy is going to be the cut-off date for filing of bankruptcy preference claims. However, to properly determine the statute of limitations in a case that has been converted from Chapter 11toChapter 7,it is necessary to know the date a trustee was appointed. The transfer must have happened during a 90-day (1 year in case of insider) period before the bankruptcy. The period differs depending on how the bankruptcy was commenced. For a bankruptcy started by a: (1) Creditor’s Petition – 6 months before the filing of the creditor’s petition (2) Debtor’s Petition (where a Creditor’s Petition is pending) – the period starts on the commencement of the bankruptcy; defined as the time of the earliest act of bankruptcy within the 6 months before the creditor’s petition was filed. (3) Debtor’s Petition – 6 months before the presentation of the Debtor’s Petition

You should contact a competent bankruptcy attorney to determine whether or not there are defenses tothetrustee’s preference action.

Section 547 ofthe Bankruptcy Code authorizes a trustee to invalidate certain transfers of property made by a debtor before the filing of its bankruptcy petition. The key characteristics of such transfers are that it (a) was a transfer of the debtor’s property, (b) was made within 90 days before the filing of the bankruptcy petition and (c)was made on account of a pre-existing (͞antecedent͟) debt owed to a creditor by the debtor. A lien granted under these circumstances is vulnerable to avoidance, which would leave the once-secured creditor with an ordinary, lower-priority unsecured claim for repayment of its loans.

The Act has a special provision that applies to bankruptcy cases filed by a debtor whose debts are primarily business debts, as opposed to consumer debts. (Consumer debts are those incurred primarily for a personal, family or household purpose. Business debts are all other types of debts.) In cases involving primarily business debts, the Act prohibits actions to recover preferential transfers unless the total of all of the allegedly preferential transfers received by a particular creditor is at least $5,000 or more. This will eliminate smaller preference actions and is a welcome change for creditors that extend credit to their business customers.

In most cases, when the transfer has occurred is apparent. However, in some cases, it may not be clear. The time of transfer is important, because only by knowing when the transfer occurred can it be determined whether it occurred within the preference period, whether the debtor was insolvent at the time, and whether the transfer was for an antecedent debt.

After bankruptcy has been declared, your reclamation rights are governed by the Bankruptcy Abuse Prevention and Consumer Protection Act of2005. The new bankruptcy law expands your rights to reclaim goods purchased from you by someone who has filed bankruptcy: You can assert a reclamation demand for goods received within 45 days of the bankruptcy filing by filing a written demand. The goods must have been sold in the ͞ordinary course͟of your business and the goods must have been received while the debtor was ͞insolvent͟ (using the bankruptcy definition above). If the 45-day period expires after the bankruptcy case is filed, you must make the reclamation demand within 20days after the bankruptcy filing.

In personal insolvency matters, only trustees of bankrupt estates and trustees of Personal Insolvency Agreements (where the Agreement includes recovery of these preferential transactions) may claim the return of preferential payments.

The Bankruptcy Code permits a trustee to avoid and recover such payments. The policy behind this rule is to diminish the advantages that a creditor might get by litigation o rby aggressive collection actions that force the debtor into bankruptcy. The trustee’s main role is to distribute the bankrupt’s assets fairly between their creditors. To do so, the trustee must discover whether any creditor has received treatment that would have given him a distribution – before the bankruptcy – that was not equitable when compared to the distribution given to the other creditors in the bankruptcy. Hence, the Trustee is able to void transactions that involve one creditor so that they can make a more equitable distribution to all creditors. With respect to insiders, the policy is to prevent those closest to the debtor, who may have advance knowledge of the debtor’s financial distress, from gaining an advantage at the expense of other creditors who were ignorant about it.

Critical/Special Vendors are not immune from preference risk.

Bankruptcy preference law generally does not consider whether the business knew that the debtor was insolvent or if it was trying to gain preference over other creditors from the debtor’s last bit of available cash. Therefore, even ͞good guys͟ can fall victim to a preference lawsuit if all six elements are present. The end result of a successful preference claim is that the plaintiff gets the ability to avoid or take back the transfer from the creditor, and the creditor has a corresponding claim against the debtor’s estate.

Bankruptcy preference law generally does not consider whether the creditor business knew that the debtor was insolvent or if it was trying to beat other creditors to the debtor’s last bit of available cash. Therefore, even ‘good guys’ can fall victim to a preference lawsuit if all six elements are present. The end result of a successful preference claim is that the plaintiff gets the ability to avoid or take back the transfer from the creditor, and the creditor has a corresponding claim against the debtor’s estate.

What is the best way to respond to a preference demand letter?A business facing a preference allegation usually learns of the allegation from one of the two sources. The business may get a letter from a representative of the debtor’s estate that details the allegation and typically demands payment based on the allegation or proposes a settlement. Alternatively, the business may be served with a complaint filed in a bankruptcy court where the debtor’s bankruptcy is pending. The initial reaction to a formal or informal preference demand is anger and frustration. Though it seems to be unfair notion that the debtor has the right and audacity to recover a payment for a legitimate debt from one of its loyal customers, it may be recovered as per Bankruptcy laws. A preference demand letter should neither be ignored nor feared. Rather, it should be considered as an opportunity for creditors to fully utilize the defenses available to them under the Bankruptcy Code. Ignoring an informal demand letter may result in the business wasting an opportunity to achieve a cost-effective and reasonable settlement that gets out of the hand once formal litigation is initiated. Further, ignoring a complaint or other formal legal pleading may result in the loss of a common, meritorious defense to the preference allegations. Therefore, when a business receives a notice of a preference complaint it should adequately and timely respond to the allegations, preferably with the assistance of legal counsel.

Unless the customer files for bankruptcy protection within 90 days of your receipt (and, in the case of a check, it being honored by the payer’s bank) of the transfer, there is no preference exposure. However, if the customer does file for bankruptcy protection during the90 days after receiving the potential preferential transfer, it is possible that the person receiving the transfer may be sued to recover the transfer.

So far, you accept that you may later be sued for recovery of the alleged preference, the answer is yes. First, the customer may never file bankruptcy, or may do so more than 90 days after making the transfer to you. Second, you may have defenses to the alleged preferential transfer which will allow you to retain some or all of the payment. Finally, at the least you get to keep the transfer, interest-free, until the customer or a bankruptcy trustee actually sues you and successfully recovers it.

In a Chapter 11, the debtor is the first owner of preference claims. If the debtor is still a ‘debtor in possession’ when the adversary proceeding is brought, then you will be dealing with one of two sets of lawyers – either the debtor’s lawyers or the lawyers for the creditors committee. (In some cases, the bankruptcy court will order the creditors committee to take over the task of collecting preferences.) If a ‘Plan of Liquidation’ has been approved in the bankruptcy case, the preference action can be brought by the debtor, the creditors committee or the ‘plan administrator’. This was the situation when the sample complaint below was filed. If the Chapter 11 has been converted to a Chapter 7, the trustee is the ‘plaintiff’ in the adversary proceeding. The trustee’s lawyers are the lawyers who you will be dealing with. The trustee’s lawyers may have been hired just for the purpose of bringing preference actions. If the debtor has sold all or most of its assets in a court approved bankruptcy sale (a ‘Section 363 Sale’), then the right to bring bankruptcy preference claims may have been sold to the purchaser as part of the Section 363 Sale. If this purchaser buys the preference claims and decides to pursue collection, then you might be dealing with the purchaser and its lawyers.

The person bringing the preference claim may be the debtor, the trustee, the creditor committee, a plan representative or a purchaser under a Section 363 sale. Bankruptcy preference claims are time barred after the later of 2 years after the bankruptcy filing or 1 year after the appointment or election of the first trustee. Alternatively, if a trustee is appointed in the second year of a bankruptcy, it will have a full year to decide whether or not to bring preference claims.