Preference Payments - Part 1: The Basics

As a vendor or supplier, it is frustrating to receive a letter from a lawyer claiming that you received a “preference” payment from a customer and demanding that you give the money back. You did the work, supplied the goods, or performed the services, and the customer accepted them without complaint. Why should you have to repay the customer for a completed job?

A preference is a payment made from a debtor to a creditor, on account of a debt, while the debtor was insolvent, within 90 days before the debtor filed for bankruptcy protection. If these, and a few other conditions are met, the debtor may recover a payment that was made within 90 days prior to bankruptcy filing. Unfortunately for vendors, timing of the payment and the bankruptcy filing are critical for preferences, and a vendor usually has little control over these variables.

The underlying premise of the bankruptcy code is to maximize recovery for all creditors. When one vendor is paid on the eve of bankruptcy filing while other vendors remain unpaid, the preference rule aims to correct the inequity. It is possible that the vendor who got paid had a better relationship with the debtor or applied more aggressive collection efforts, which motivated the debtor to pay it instead of other vendors. In bankruptcy, all vendor and supplier claims are entitled to the same priority of payment. This means that a debtor cannot choose to pay one vendor in full while others remain unpaid.

When a preference payment is avoided, the funds are returned to the debtor and redistributed to all vendors and unsecured creditors on a pro rata basis. Depending on the size of the debtor, it may have hundreds or thousands of preference claims against vendors. If your company is the recipient of a preference demand letter, there are a number of defenses that may be asserted to lessen or absolve preference exposure. It is important to act quickly to ensure that no deadlines are missed after receiving a preference letter.

Allen M. DeBard

Allen is a shareholder in Langley & Banack’s bankruptcy and workouts section. In all representations, Allen focuses on the details of each case and the client’s goals. This allows him to map out a course for the case and anticipate potential issues before they arise. This detailed analysi...