Deborah Thorne

Friday, 29 October 2004 05:28

Understanding the Bankruptcy Code

The Bankruptcy Code was designed to protect two distinct interests -- that of the debtor to obtain a fresh start and that of the creditor to be treated fairly along with other creditors. Since its enactment in 1978, although many interest groups have tried to obtain better treatment for themselves, the two basic tenets upon which the Bankruptcy Code is premised remain in place.

One way Congress attempted to provide equal treatment for creditors was through section 547 of the code, which allows the trustee or the debtor in possession to avoid or recover payments made to creditors during the 90 days prior to filing a bankruptcy petition. Payments are recoverable only if the trustee can prove certain items and the recipient cannot prevail on any of the defenses available.

Here is an overview of the proof the trustee must make and the more common defenses that the creditor may assert.


Protection in the face of preference demand

The trustee must file a preference case within two years from the date the bankruptcy petition is filed. At the time that you, as a creditor, receive the letter or before, analyze your preference risk. Has the trustee met the burden of proof as to whether a preference exists? What defenses do you have? What is your potential risk? What will it cost to defend your case?

After determining the answers, you should, with the help of your attorney, respond with a letter outlining your defenses and attempting to settle. A carefully drafted response may eliminate a lawsuit and reduce your legal costs.


Trustee's burden of proof

The trustee must prove the following if he or she is to recover the alleged preferential payment.


* The payment was to or for the benefit of a creditor.


* The payment was for or on account of a past due debt owed by the debtor before the payment was made.


* The payment was made while the debtor was insolvent


* The payment was made within 90 days before the date of the bankruptcy petition or within one year before the date of the bankruptcy petition, if the recipient is an insider of the debtor.


* The payment enables the creditor to receive more than it would receive if the case were a Chapter 7 case, the transfer had not been made and the creditor received payment of its claim through the Chapter 7 distribution.


If the trustee cannot prove each of the above elements, the case should go no farther.


Your defenses

The Bankruptcy Code provides certain defenses to a preference action. The defending creditor has the burden to prove each defense is valid.


* Contemporaneous exchange. To the extent the transfer was intended by the debtor and the creditor to be contemporaneous for a new shipment of inventory or provision of services and in fact was contemporaneous. COD payments should be considered contemporaneous and subject to this defense.


* Ordinary course. To the extent the transfer is payment of a debt incurred in the ordinary course of business of the debtor and the recipient; the payment is made in the ordinary course of business of the debtor and the recipient; and is made according to ordinary business terms, the defendant creditor can assert this defense to protect the payment or transfer. The bottom line for ordinary course is that this is a fact-intensive defense and generally subjective.


* New value. To the extent that after each transfer is made, the creditor supplied "new value" to the debtor, the creditor is able to assert the value of the new inventory or services supplied as a credit against the transfer. Only value provided after the transfer is available to be used as a credit.

Depending on which bankruptcy court the case is brought in, the defending creditor may be able to assert this defense whether or not the "new value" is paid. Check with your attorney to see what the case law is in the circuit in which your case is brought.


Deborah L. Thorne is a partner in the Chicago office of Barnes & Thornburg LLP. She concentrates her practice in the areas of creditors' rights, bankruptcy, financial restructurings and commercial transactions. Reach her at (312) 214-8307 or

Thursday, 23 June 2005 20:00

Significant changes

Business transactions will be significantly affected by the recent passage of the Bankruptcy Abuse Prevention and Consumer Act of 2005 when most of the provisions go into effect on October 17, 2005. While many of the provisions affect consumers, there are some that could have a significant impact on businesses. The following are some of the most important business-changing provisions.

Reclamation rights. Under the New Act, reclaiming creditors will be entitled to reclaim goods shipped and received by the debtor/buyer 45 days prior to a bankruptcy if notice is given in writing to the debtor/buyer. Previously, the sellers of goods, under most state laws and under the current bankruptcy code, were entitled to a reclamation claim for goods delivered to the debtor/buyer 10 days prior to written notice to the debtor/buyer.

In addition, under the new act, the reclaiming creditor is entitled to an administrative claim for all goods received by the debtor/buyer 20 days prior to the bankruptcy petition. The administrative claim must be paid at or before confirmation of the plan of reorganization. If the administrative claims are not paid, the debtor cannot confirm its plan. Administrative claims must be filed with the bankruptcy court and a motion must be made for payment. Administrative claims are not sufficient if filed on a "proof of claim" form.

Warehouseman's liens. Under the new act, a trustee may not avoid a lien for storage, transportation or other charges for the storage and handling of goods.

Creditors' committees. The bankruptcy court may now order the U.S. trustee to adjust the number of members and the makeup of committees in Chapter 11 cases. So, if a small business has a "large" claim against the debtor, it may be added to the committee, and can then play an active role in the case.

Preferences. Under the old act, bankruptcy attorneys or trustees could file a preference action, and business owners were forced to return all payments received in the 90 days prior to the debtor filing for bankruptcy, unless the defendant could successfully assert certain defenses. One of the most common defenses was that the payment was made in the ordinary course of business. Under the old act, the "ordinary course of business" defense required that the creditor prove that the payment was ordinary between the creditor and the debtor and that it was ordinary in the industry of the creditor. Under the new act, the defendant, usually a business owner, must only prove that the payment was made in the ordinary course between the debtor and creditor or in the ordinary course of the creditor's industry. This may make it more difficult for bankruptcy attorneys or trustees to recover preferential payments in many situations and easier for creditors to defend.

In addition, plaintiffs may not sue a business creditor in a preference case if the amount at stake is $5,000 or less. If the amount at stake is $10,000 or less, the plaintiff must bring the action where the defendant/creditor is doing business. Thus, if the bankruptcy case is filed in another jurisdiction (most business bankruptcy cases are filed in Delaware and New York), creditors with small amounts at stake will only be required to defend a preference action in a court near where they are doing business.

Deborah L. Thorne is a partner in the Chicago office of Barnes & Thornburg LLP. She concentrates her practice in the areas of creditors' rights, bankruptcy, financial restructurings and commercial transactions. Reach her at (312) 214-8307 or