When Getting Paid Doesn’t Pay - Defending Preference Actions under Section 547 of the Bankruptcy Code

For an Atlanta, Georgia small business owner, being paid by a client or customer for a past-due invoice is typically a cause to celebrate. However, when that client or customer happens to then file bankruptcy within 90 days of making that payment, the celebration can quickly become a headache.

Section 547 of the Bankruptcy Code allows a bankruptcy trustee (or, in some Chapter 11 cases, the debtor individual or corporation itself) to “avoid” certain payments made within 90 days of the “Petition Date” (the day the bankruptcy case was filed). These payments, referred to as “preferences”, are payments that allowed a creditor or vendor to receive more favorable (preferential) treatment to a debtor’s other unsecured creditors. Preferential payments may be recovered by the trustee or debtor from the recipients of such payments. 

Under Section 547(b) of the Bankruptcy Code, a transfer or payment is a preference if it is made (1) to or for the benefit of a creditor; (2) for a debt existing before the transfer or payment was made; (3) while the debtor was insolvent; (4) within 90 days before the Petition Date (or, one year, if the recipient of the transfer or payment is an “insider”); and (5) in an amount such that the recipient of the transfer received more than would have been received if the recipient’s claim had been paid after a liquidation of the debtor’s assets by the bankruptcy trustee in a chapter 7 bankruptcy case. A recipient of a transfer is an “insider”, triggering the longer one-year avoidance period, if the recipient is a relative of, general partner of, director or officer of, or relative of a director or officer of, the debtor.

Not every payment received from a bankrupt debtor within 90 days of the Petition Date is automatically a preference which can be avoided. Section 547(b) of the Bankruptcy Code provides a couple of obvious defenses to such a claim; if the debtor was solvent at the time of the transfer, or if the amount received can be shown to be no more than what the creditor would receive in a chapter 7 liquidation, there is no preference. Section 547(c) provides additional defenses to a trustee’s or debtor’s preference claim. For instance, among other reasons, a preference cannot be avoided if the debtor, at the time the transfer was made, received new value for the transfer.

The most commonly invoked defense to a preference claim, also found in Section 547(c), is that the payment or transfer “was in payment of a debt incurred by the debtor in the ordinary course of business or financial affairs of the debtor and the transferee” and that the transfer itself was also “in the ordinary course of business or financial affairs” of the debtor and the recipient. In other words, if a debt, bill, or invoice paid within 90 days of the Petition Date was paid within the time and in a way typical of past payments between the debtor and the creditor, the preference may not be avoided.

If you or your business receives a demand letter or complaint for turnover of preference payments, careful, thorough analysis from skilled legal counsel is needed to determine whether the trustee or Chapter 11 debtor has a valid claim and, if so, whether any defenses under Section 547(c) of the Bankruptcy Code are available. Even in situations where there are no strong defenses to a preference claim, such claims can often be settled through the efforts of experienced attorneys.

Since 1986, the Rothbloom Law Firm has served individuals and businesses in Cobb, Fulton, Gwinnett, Paulding, Cherokee, DeKalb, and all other metro-Atlanta counties. Our attorneys, Howard Rothbloom and Adam Herring, provide thoughtful counseling, careful planning, and creative lawyering in representing Georgia individuals and small businesses in bankruptcy and bankruptcy-related proceedings, including defending or settling preference avoidance actions.