Defending against preference repayment demands

Posted on: June 16th, 2023 by Ag & Business Legal Strategies

Taking a break from the morning’s work, you stop by the mailbox only to find an unfamiliar envelope from some law firm. The letter inside is notification that the XYZ Grain Elevator has filed for Chapter 11 bankruptcy reorganization, and as part of this, you might have to turn over to the court a good chunk of the $50,000 soybean check you received two months ago!

Are you legally obligated to return your payment so XYZ’s other creditors can be paid? What are your options, and can you effectively defend your right to keep what you were owed?

What is bankruptcy preference?

In bankruptcy parlance, a “preference” is receipt of payment or other transfer of assets from a debtor to a creditor that takes place during or shortly in advance of the debtor filing for bankruptcy protection.

It’s called that because it appears the debtor (XYZ Grain Elevator) is showing preference to this particular creditor (you) by paying them while leaving other creditors unpaid. It means you are potentially receiving a better payment than the court would be able to distribute among XYZ’s other creditors after liquidation of its assets through the bankruptcy process.

A preference, therefore, enhances the preferred creditor’s recovery at the expense of similarly situated creditors.

Let’s consider Bill, who decides he’s going to pay half the $50,000 he owes on a used tractor, to get the dealer, ABC Equipment, to stop haranguing him for payment. If Bill pays $25,000 and files for bankruptcy shortly thereafter, ABC Equipment has received 50 cents on the dollar of what it is owed, when the bankruptcy court might later determine all creditors will only be paid 10 cents on the dollar.

That is a preferential payment, and the bankruptcy trustee could send ABC a letter demanding it return most of Bill’s $25,000 payment to the court, to be split among other unpaid creditors. Preference recoveries allow the bankruptcy court to “level the playing field” so all creditors get a fair shot at their percentage share of the debtor’s liquidated assets as repayment.

Time limits on preference

There is a “lookback period” to define what is a preferential payment. For general creditors, it’s within 90 days before the filing for bankruptcy. If Bill pays ABC Equipment $25,000 on June 30 and files on September 10, the trustee could send ABC a demand letter.

But it’s not just what day the check was issued. If Bill doesn’t file for bankruptcy until October 30 but ABC waited until August 10 to deposit his check, ABC could still be subject to a demand letter.

The 90-day lookback period is extended to one full year for creditors considered to be “insiders,” such as family members up to three degrees removed (up to a third cousin) or partner in a business.

Consider the situation with Bill above. Let’s change the situation so that his first cousin, Tom, is actually a co-owner in ABC Equipment. In this case, the bankruptcy trustee could look all the way back to October 30 the previous year for any possible preferential payments.

Congress believed “blood is thicker than water,” and that chances are high a debtor will pay their relatives before general unsecured creditors.

One additional note on preferential payments: These are not just checks or cash payments, but any transfer of assets to satisfy a debt. For example, if a debtor transfers title to their vacation home to a creditor within the lookback period, the trustee and court could view that as a preferential payment.

Mounting a defense

No matter what kind of bankruptcy a debtor files—Chapter 7, 11, 12, or 13—the same federal code applies with respect to preferential payments. If you receive a demand letter as a creditor, it is important that you determine whether you have a valid defense against preference repayment.

The best course is to consult with an attorney who knows the Bankruptcy Code and how to deal with preference demand. We have represented clients on both sides of preference letters.

There are four types of defense a creditor may use against a preference letter.

Prove payment took place in the ordinary course of business.
Show it is custom within the industry for payment to take place in a certain period of time.
Demonstrate contemporaneous exchange for value—e.g. cash on delivery transactions.
Establish new value has been provided since the debtor’s payment—a creditor who receives a $25,000 preferential payment but then extends $15,000 more credit is only liable for a $10,000 preference.

Don’t fear being paid

Farmers selling grain or livestock do have some federal and state regulatory protections. The federal Packers & Stockyards Act regulates how quickly livestock and poultry producers must be paid, which is often a solid defense against preference repayment demands. State licensing requirements and grain indemnity funds are typically in place to cover grain elevator defaults. A farmer with these protections might still receive a preference demand letter, but these regulatory protections can help mount a defense.

Ag & Business Legal Strategies recommends keeping records on your sales & purchases for your farm or business and tracking when you are paid & if you are not getting paid on time. If you are owed money, keep pursuing payment from a debtor—don’t let the prospect of a preference letter later on keep you from accepting payment. Remember, getting paid for certain with only a possibility of having to pay part of the money back is better than having your whole accounts receivable sitting out there and getting cents on the dollar in a hypothetical bankruptcy.

If you receive a preference demand letter from a debtor or trustee, be proactive and reach out to us. Don’t wait—do it right away!

At Ag & Business Legal Strategies, we want our clients to be honest with themselves and have a solid business plan. Our attorneys and financial strategist will help you create and execute that business plan, and, if necessary, assist you with the legal, tax, and practical aspects of debt restructuring or bankruptcy.

Don’t wait for the problems to become insurmountable. Connect with someone you can trust today, not tomorrow.

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