One question that clients often ask is what measures can be taken to reduce preferential exposure when dealing with a company that is sliding into financial insolvency. Under Section 547 of the Bankruptcy Code, a debtor or trustee can seek to avoid and recover payments made to a vendor that provided goods or services to the debtor in the 90 days prior to the filing of bankruptcy.
It is important to take into account the fact that in order to demonstrate that a payment is “preferential”, the elements of Section 547(b) of the Bankruptcy Code must be met. One of the elements that must be satisfied, among others, is that the transfer was made “for or on account of an antecedent debt owed by the debtor before such transfer was made”. 11 U.S.C. Section 547(b).
What this means is that the transfer must be in payment of goods or services previously provided to the debtor. Accordingly, any transfer from the debtor to your company that is a prepayment cannot qualify as a preferential transfer by statute. Therefore, in dealing with a company that is close to filing for bankruptcy, a good practice is to require that it pay up front for any goods or services. Not only will this limit your preferential liability, but it will also allow your company to avoid having a large unpaid balance at the time of the debtor’s filing of bankruptcy, for which you may receive pennies on the dollar.
Carl D. Neff is a bankruptcy attorney with the law firm of Fox Rothschild LLP. Carl is admitted in Delaware and regularly practices before the United States Bankruptcy Court for the District of Delaware. You can reach Carl at (302) 622-4272 or at firstname.lastname@example.org.