How you might have to return a payment to a company that files for bankruptcy

Stephen C. Goldblum, member, Semanoff Ormsby Greenberg & Torchia, LLC

Stephen C. Goldblum, member, Semanoff Ormsby Greenberg & Torchia, LLC

A “preference action” is a lawsuit by or on behalf of a debtor seeking to recover certain payments made by the debtor prior to filing for bankruptcy. Preference actions are unfamiliar to many business owners and often seem illogical and unfair.

“Clients often receive a letter demanding the return of a payment that the debtor made to them before filing for bankruptcy. They call and say, ‘What does this mean? Do I have to return this money? We sold them products and they paid us, are they entitled to get their money back?’” says Stephen C. Goldblum, member at Semanoff Ormsby Greenberg & Torchia, LLC. “The answer is yes, you may have to return the money — unless the payment falls within one of the statutory defenses.”

Smart Business spoke with Goldblum about how preferences work.

What should you know about preferences?

Typically, a preference action is often preceded by a ‘demand letter’ from the debtor demanding the return of payments made in the 90 days prior to the debtor filing for bankruptcy. This seems patently unfair to the recipient of the payment. The business provided products or services and was paid for them, and it seems unjust to have to return the money, often many months after the payment was received. The policy behind the bankruptcy code, however, takes a broader view. The policy is to prevent debtors from treating creditors unequally and paying preferred creditors before filing bankruptcy, and to prevent aggressive collection activities that could actually force a debtor into bankruptcy. Such policies have been determined to be of greater importance than the rights of an individual creditor.

There are four elements needed to prove a preferential payment; if the payment was:

  • For an antecedent (previously incurred) debt.
  • Made while the debtor was insolvent.
  • Made to a non-insider creditor in the 90 days prior to the bankruptcy filing.
  • Allows the creditor to receive more than it would have if the payment had not been made and the claim paid through the bankruptcy proceeding.

Where do many businesses make mistakes regarding preferences?

A business’ biggest mistake is to ignore a demand letter received by or on behalf of a debtor. Often the debtor is willing to settle the preference claim for a significantly reduced amount before a lawsuit is filed. A business that ignores a demand letter or fails to timely retain counsel familiar with bankruptcy law often misses its best opportunity for a favorable resolution.

Do you receive the repayment back?

Usually not. The preferential payments recovered by the debtor are added to the bankruptcy estate. To the extent there are funds available, secured, priority and certain other creditors are paid first. To the extent there are funds remaining, they are distributed to the unsecured creditors, which often results in little or no payment.

What are the defenses when a payment is alleged to be preferential?

The three primary defenses to an alleged preferential payment are the following:

  • New value defense, which provides an offset against the preferential payment if the creditor subsequently gives new value to the debtor after the alleged preferential transfer.
  • Ordinary course of business defense, which protects transfers consistent with the debtor and creditor’s prior business history.
  • Contemporaneous exchange defense, which includes certain concurrent transactions such as a cash-on-delivery.

How are insider creditors treated differently?

With insiders — corporate officers or directors, relatives and related entities — a debtor may recover payments for up to 12 months prior to the bankruptcy.

How can you protect your company? 

It’s difficult for a company to pre-emptively protect itself from a payment later being deemed preferential. When you receive a letter demanding return of an alleged preferential payment, contact an attorney experienced with creditors’ rights. He or she will analyze the potential defenses and prepare a response to the letter. Often, a timely, well-reasoned response to a demand for the return of a preferential payment leads to a prompt and cost-effective resolution.

Stephen C. Goldblum is a member at Semanoff Ormsby Greenberg & Torchia, LLC. Reach him at (215) 887-5961 or [email protected]


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Judge approves $21 million in cash for MF Global bankruptcy

NEW YORK ― A bankruptcy judge approved on Wednesday a deal to allow collapsed broker MF Global Holdings Ltd. to finance the rest of its bankruptcy with about $21 million in cash pledged as collateral to JPMorgan Chase & Co., one of its primary lenders.

Judge Martin Glenn green-lighted the deal at a hearing in U.S. Bankruptcy Court in Manhattan, but was also receptive to an objection from customers who worried that the cash could be part of an estimated $1.2 billion in funds missing from their accounts at MF Global’s brokerage.

Glenn said he may order James Giddens, the trustee liquidating the brokerage, to investigate whether customers might have a right to the money.

“I’m sensitive to this, because if I wait a year from now, most of the money in this account may have been spent and won’t be able to be recovered,” Glenn said.

He did not make a final ruling on the investigation, but said he would issue an order later on Wednesday.

FDIC settles with former Washington Mutual executives: sources

SEATTLE, Wash. ― Three former executives of Washington Mutual Inc. have agreed to a payment of about $75 million to settle a lawsuit brought by the Federal Deposit Insurance Corp. over their role in the biggest bank failure in U.S. history, two sources familiar with the talks said on Tuesday.

The three — former CEO Kerry Killinger, former COO Stephen Rotella and the company’s former home lending chief, David Schneider — were sued by the government’s deposit insurer last March.

The payment will be largely funded by Washington Mutual’s remaining liability insurance for directors and officers, the sources said. The FDIC originally sought $900 million.

One source said the personal contribution from the three, who collected $95 million in compensation between 2005 and 2008, would be “a meaningless amount.”

The settlement was first reported by the Wall Street Journal.

The FDIC declined to comment but is expected to make an announcement later on Tuesday.

Attorneys for Killinger, Rotella and Schneider did not immediately return calls seeking comment. The three have denied wrongdoing.

Washington Mutual’s banking business was seized by regulators in September 2008, at the height of the global financial crisis. The bank was immediately sold to JPMorgan Chase & Co for $1.88 billion, with no cost to the FDIC for covering deposits.

The holding company filed for bankruptcy the day after the bank seizure.

On Monday, the holding company reached an agreement with shareholders that could clear the way for it to end its three-year stay in Chapter 11 and begin distributing $7 billion to creditors.

An investigation by the U.S. Senate found that Washington Mutual contributed to the U.S. housing and financial crisis by adopting a compensation policy that encouraged its employees to ignore safety controls and crank out shoddy home loans.

Those loans were packaged into bonds and sold as top-notch securities. When U.S. housing market collapsed, those bonds plummeted in value and spread financial losses around the globe.

The FDIC brought its case in federal court in Washington state, accusing the three former executives of gross negligence and reckless disregard for the long-term safety of the bank.The lawsuit was unusual in that it also named the spouses of Killinger and Rotella as defendants and accused them of helping their husbands hide assets, such as homes, from creditors. The claims against the spouses will be dropped and they will not contribute to the settlement, one source said.