Q We are a small carrier that extended extra credit to a home-town manufacturer during hard times. It paid us a chunk of its past-due freight bills right before it filed bankruptcy, and now its trustee wants us to give that money back. This does not seem fair. Is it the law?
A You are talking about a preference action brought by the trustee under Section 547 of the Bankruptcy Code. It’s an all-too-frequent occurrence. In theory, no unsecured creditors should get preferential treatment, so the trustee can demand that anyone who was paid within 90 days before the filing must return their payment so that the money, less administrative costs, can be redistributed more equitably under the bankruptcy guidelines. In practice, many trustees view preference actions as “easy money” and send demands out to every creditor for repayment.
Preference actions make good work for lawyers since some of our larger clients have been faced with six-figure demands. If you are the target of a preference action, you will receive a summons by ordinary mail requiring you to answer or appear in some distant bankruptcy court on short notice. If you ignore the summons, a judgment will be entered against you.
Defending against a preference action successfully will take some work and some legal talent because the burden of proof is on you. The two most frequent defenses are “ordinary course of business” and “new value.”
The so-called ordinary course of business defense is a two-pronged test. A payment by the debtor within 90 days of bankruptcy is not a preference if it is (a) in the ordinary course of business and (b) in the ordinary course of your business transactions with the debtor. Since most payment of freight charges are ordinary course of business items, proving this defense usually boils down to an analysis of your payment terms and when the debtor paid its freight charges. Although there is no general rule, typically freight charges that are paid within less than 60 days are considered timely.
To satisfy the trustee, you will also have to show that during the 90-day preference period, the debtor paid you within the same time parameters as it did before the preference period. The analysis is fairly sophisticated, but in layman terms this means you must be able to show statistically that you did not, in fact, cut the debtor a break and extend more favorable terms to him when he fell on hard times. I know this is counter-intuitive and it seems like “no good deed goes unpunished,” but this is how the bankruptcy law is applied.
The second defense is the new value defense that allows you to escape preference liability by giving up your claim for unpaid freight charges to the extent that those charges were incurred after you received the payment that the trustee claims is a preference. As a practical matter, motor carriers are most often generally unsecured creditors in bankruptcy proceedings, and giving up their claim, to the extent possible to avoid a preference action, is no loss.
Small carriers in particular should recognize three things. First, if you haven’t yet been hit with a preference action, stay in business and you will get one. Second, when you get a demand or summons from a trustee demanding return of funds you worked long and hard to get, remember that you have defenses but that the unfairness of the Bankruptcy Code is not one of them. Third, you cannot afford to be a nice guy and let a shipper that has fallen on hard times slow its payments to you. The Bankruptcy Code forces you to demand continued on-time payments for fear that what you ultimately get you will not be able to keep.