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How to Successfully Dispute a Preference Claim in Bankruptcy
By Michael C. Dennis, MBA, CBF

Bankruptcy Articles
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Disclaimer: This information is not intended as legal advice, or as a substitute for legal advice. It is for informational purposes only.

Not every Preference Claim can be successfully disputed or negotiated down…but many can be. Here are some tools and tips that will make you better prepared for the process:

Address the Preference demand as soon as it is received. Don’t wait until the last minute.

Try not to involve your attorney at first in the negotiation process.

Ask your attorney about whether you have a valid defense against the Preference claim. When you have a valid defense to the Preference claim, assert it. Do so promptly and forcefully. Always provide copies of all relevant supporting documentation relating to the defense or defense you are asserting.

Provide the debtor or trustee with a clear, written explanation of your objections to the preference claim. Remember that the bankrupt debtor’s records are often a mess. As a result, initial preference demand letters are usually generated to each and every recipient of payments a payment within the 90-day look back period --- regardless of the terms of sale and without any analysis of the validity of the preference claim.

Enter into the negotiations with a positive attitude…an attitude that suggests there is a solution to the dispute and that both you and the debtor’s representatives as reasonable businesspeople can find that solution together.

Consider the timing. The claimant may show less flexibility at the beginning than after most claims are resolved, and the rest are set for trial.

Remember that the smaller the preference claim, the less time the creditor wants to devote to it. Consider offering a nominal amount as a way to settle a small dollar preference claim cheaply and quickly.

Never send original documents. You may need them at trial, and you are never sure you will get them back from trustee or the debtor.

Remember that no one wants to go before the bankruptcy judge on a preference claim, no matter how cavalier the trustee, or debtor, or attorney sounds about it.

Recognize that in many cases the trustee, attorney or collection firm is employed on a contingency basis. This generally encourages the claimant to try to settle claims quickly while spending as little time as possible.

Upon receipt of a preference notice, respond to the sender that you find NO claims that appear preferential. Ask the debtor to supply you with copies of all relevant documents as well as a request that the claimant describe the basis of their claim against your company. Once you know the basis of their claim, you can establish your company’s defense or defenses.

Consider offering or accepting a settlement. When doing so, factor in the time and the cost of going to trial.

An Overview of the Most Commonly Used Defenses Against Demands for the Return of Preferential Transfers

1. An Overview if the New Value Exception:

New value given to the debtor involving sales made to the debtor during the 90-day preference period reduces the size of the preference.

Receipt of preference payments can be offset by sales made on open account terms if the debt that arose from those sales remained unpaid at the time of the bankruptcy filing.

2. An Overview of the Ordinary Course of Business exception:

Payments received in the ordinary course of business are not preferential…but the burden is on the creditor to prove this exception applies…and Courts and trustees tend to interpret this particular exception narrowly. Courts look at industry standards, as well as to the creditor’s payment history with the debtor. In addition, different district courts have varying interpretations of what constitutes a payment in the ordinary course of business.

3. An Overview of the Contemporaneous Exchange of Value Exception:

An example would be a sale made on COD or wire transfer terms during the preference period. This exception applies only to the extent the new value equals the payment received. For example, if a creditor demanded a 3 for 1 exchange, only 1/3 of the payment received would not be considered preferential.

4. An Overview of the Subsequent New Value Defense

This defense provides that the trustee may not avoid a transfer to or for the benefit of a creditor, if the creditor gave new value to the debtor (i.e., a subsequent shipment of goods) after the payment, which was not secured by an otherwise unavoidable security interest and on account of which new value the debtor did not make an otherwise unavoidable transfer to or for the benefit of the creditor.

5. An Overview of the Defense Relating to No Improvement In Position By A Secured Creditor:

A trustee may not avoid a transfer of a perfected security interest in inventory or receivable or the proceeds of either, except to the extent that the aggregate of all such transfers (or perfected security interests) caused a reduction in the ratio between the indebtedness to that creditor and the value of that creditor’s
collateral as of the date of the petition and the 90th day prior to the bankruptcy filing date - which prejudices other creditors holding unsecured claims.

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