With the economy still in the doldrums, corporate bankruptcies still make the news every day. What you don’t hear about are the large law suits filed by bankrupt estates demanding money from vendors for payments made to them within 90 days from the filing date. Known as a bankruptcy preference action, the number of these filings has been growing exponentially since the beginning of 2010.

What do you do when you receive a notice in the mail that a firm that you used to do business with two years ago filed bankruptcy and left you with a bad debt for thousands of dollars is now demanding the repayment of all payments made to you during the 90 days prior to their filing date?

1. Don’t panic.
2. There are defenses to these actions.
3. Records will need to be resurrected and an analysis of the events completed.

Hiring an attorney and perhaps an expert witness to assist in the defense must be considered.

Possible Defenses

So where do you start?

• Contemporaneous Exchange: In layman’s terms C.O.D. or cash in advance. If you sold to the bankrupt company using these terms exclusively during the 90-day preference period then you should have a complete defense.
• New Value. Assuming this was not the case, this is your next defense. This is a complex financial analysis based on payment dates and dates the goods were received or services used.
• Ordinary Course of Business. This is the last defense to consider. This defense is very complicated and you will require an attorney here. If the amount of the preference action is substantial in your eyes, an expert witness should be hired.

What You Can Expect

The fight over preferences can get pretty ruthless, regardless of the dollar amount of the claim. Some debtors, knowing the creditor will have to spend money to hire a lawyer and perhaps an expert witness to fight the claim, will stubbornly refuse to negotiate much of a settlement hoping the creditor will settle rather than spend the money to fight.

And, it should come as no surprise to Corporate Finance Insider readers to learn that when the claims start reaching the mid-six-figure level the negotiating also gets intense. It is not uncommon to see mudslinging as the battle of the attorneys and experts heats up. While it was almost unheard of that these cases ever see the inside of a courtroom in the past, I’ve testified in court on three separate occasions in the last 24 months. Bankrupt estates need every dollar they can lay their hands on and preferences are fair game.

If the first two defenses provide sufficient coverage of the preference amount and you can locate all the necessary documents then you may wish to negotiate directly with the estate especially if the preference amount is small. If not, the next step will be hiring an experienced bankruptcy attorney located in the jurisdiction in which the bankruptcy was filed. Again records will need to be located (i.e., invoice copies, payment stubs, records of conversations and other assorted items) and supplied to your attorney.

Getting Expert Help

If the dollars are substantial to your firm, hiring an independent expert witness is a wise business decision. They are trained to provide a report that exhibits the facts and analysis of the case and establishes an opinion about the actual potential preference exposure that may exist. They will then attend mediations, be deposed and testify to their opinion of the facts in court. Using an expert witness in conjunction with an attorney provides that maximum line of defense in these proceedings and may result in a quick settlement rather going to court.

Even with all of these defenses and the best outside assistance helping you, you may still lose your case. The best defense in these cases is again a good offense. Consistency in the way you do business with a troubled company (or any company) both during the 90 days prior to the bankruptcy filing date and in the years before will be of tremendous help. Credit terms remaining the same, collection actions that follow your policy and procedures manual to the letter and never putting anything into writing that you would not like read by a federal bankruptcy judge will be the three most substantial defenses to a bankruptcy preference action.

Hal Schaeffer, Jr., CCE, CEW, a nationally-recognized bankruptcy preference expert in over 300 cases, is president of D&H Credit Services Inc., a boutique consultancy specializing in creating bankruptcy preference defenses for clients.