The credit executive is well aware of the skill needed to collect on a delinquent account, yet maintain the trade credit relationship, if management is concerned about possibly losing the customer to a competitor. With new orders, the credit executive�s job is to ensure that the debtor pays close to the invoice due date. However, should the customer face a cash crisis, they likely do not have sufficient liquid assets to pay the vendor�s invoice. Given this, the credit executive may look to alternative payment methods. The credit executive, in implementing a strategy to collect the delinquent account, may need to balance ways to minimize the risk of a bankruptcy preference suit (or strengthen defenses) should the customer later file bankruptcy within 90 days of receiving payment. Payment by credit card may be the answer. But what of the preference risk, should the vendor receive payment by credit card during the preference period?

The bankruptcy court in In re Perry² recently considered whether a vendor must disgorge payments as a preference, even though the payment was made by credit card. The court dismissed the preference suit. While the Bankruptcy Reform Act gives greater protection to vendors in challenging a preference suit under the ordinary course of business defense, the vendor still has several hurdles to overcome the preference challenge using the ordinary course of business defense. The goods news for credit executive�s with the Perry ruling is that the vendor is not required to prove up the common preference defenses, but dismissed the case based on the trustee�s failure to prove up the preference elements. The court�s ruling and its meaning to vendors is considered.

A. Accepting Payment By Credit Card in B2B Transactions

Not so long ago, a credit executive accepting payment by credit card for a B2B transaction was an aberration. Not so today. Payment by credit cards involving B2B transactions continues to increase, with over $100 billion in payments this year. Vendors, as sellers, accepting payment by credit card consider several advantages to payment by check or other forms of payment, such as: immediate payment and therefore improved cashflow, increased sales, facilitates collections as there is no accounts receivable, reduced administrative costs, minimize documents, improve financial planning and reporting and customer convenience.

B. The Preference Action and Property of the Estate

Should the credit executive receive payment by credit card and the customer payment, what is the preference risk? The Bankruptcy Code vests the debtor (or trustee if one is appointed) with far-reaching powers to avoid transfers of assets and monetary transactions prior to a bankruptcy filing. The power to avoid preferential transfers is one of the most powerful weapons a trustee has.

The Bankruptcy Code defines a preference expansively to include nearly every transfer by an insolvent debtor 90 days prior to bankruptcy. The purpose of the preference provision is two-fold. First, unsecured creditors are discouraged from racing to the courthouse to dismember a debtor, thereby hastening its slide into bankruptcy. Second, debtors are deterred from preferring certain unsecured creditors by the requirement that any unsecured creditor that receives a greater payment than similarly situated unsecured creditors disgorge the payment so that like creditors receive an equal distribution of the debtor's assets.

The debtor has the burden of proof to establish the following elements of a preference: (1) a transfer of property of the debtor; (2) transfer on account of an antecedent debt; (3) presumption of insolvency within 90 days of bankruptcy filing; (4) within 90 days (one year if an insider) before the filing of bankruptcy; (5) that enables the creditor to receive more than it would have received in a liquidation.

At issue in the Perry case was whether the debtor�s payment by credit card constituted a transfer of property of the estate, the first element the trustee has the burden to establish.

1. Property of the Estate

The Bankruptcy Code and case law defines property of the estate broadly to include all interests of the debtor in property as of the bankruptcy filing.

2. Transfer of Property of the Debtor

The Bankruptcy Code defines a property transfer broadly to include every direct or indirect, absolute or conditional, voluntary or involuntary, disposing of the debtor�s property.

The inquiry is whether the transfer diminished or depleted the cash available for distribution to creditors. By contrast, if the debtor transfers property that would not have been available to distribute to creditors, then no preference.

C. The Trade Relationship: Customer Pays by Credit Card for B2B Transaction

In In re Perry, the vendor provided goods on terms to the debtor, a sole proprietor. The debtor paid for the credit sale using his credit card. The debtor filed chapter 7 liquidation within 90 days of paying the vendor by credit card. The bankruptcy trustee sued the vendor to recover the credit card payment. The vendor sought dismissal of the preference contending that the payment by credit card was not property of the estate.

D. Decrease of Credit Line Not Transfer of Property

The Perry court considered the trustee�s contention that payment by a credit card constituted property of the estate. The court found it did not:

Despite the broad scope of $ 541, the payment at issue was not a transfer of the property of the estate. The payment constituted merely a transfer from MBNA to [vendor]. Debtor�s estate was only implicated by this transfer insofar as MNBA decreased the credit allowance under Debtor�s credit card account. Since the payment was a transfer of mere credit, and did not affect the amount of liquidity or property available for distribution by the estate�s creditors, the payment was not a transfer of an interest of the debtor in property.

* * *

At most, a debtor�s credit constitutes merely potential wealth. Creditors of an estate cannot force a debtor to use credit to create liquidity available for distribution. It is true that creditors benefit from a debtor�s credit where the debtor elects to purchase property or borrow funds from a credit card account. However, credit on its own serves no immediate benefit to the estate in bankruptcy.³

The ruling underscores that what is property of the bankruptcy estate depends on what the debtor does leading up to the preference period. Thus, if a credit executive is skilled at extracting payment from the debtor through a credit card during the preference period, the Perry court will not upset that.

E. Common Preference Defenses not Needed for Credit Card Defense

The most commonly asserted preferences by vendors are the contemporaneous exchange defense, the ordinary course of business defense and the new value defense. If the vendor sells on a secured basis, such as with a purchase money security interest, the vendor may have an enabling loan defense. In addition, vendors may have procedural defenses, including the statute of limitations defense, standing defense and demand for jury trial. The trustee generally has no duty to investigate and consider a vendor�s preference defenses, as it is the vendor�s burden to establish the defenses.

As noted, the Perry court did require the vendor to establish the elements of the preference defense. The credit card defense shifts the burden of proof from the vendor to the trustee. The trustee must prove as part of its prima facie case that the credit card payment is property of the estate.

F. Vendor May not be Free from Challenge

While the Perry ruling is welcome news for vendors fighting a preference, the vendor�s potential liability may not end with dismissal of the preference suit. The court noted the injustice to the card company, as it was substituted as a creditor with the vendor. While the bankruptcy court would not address whether the card company may charge back the transaction to the vendor, the door was opened.

G. The Lesson for Credit Executives

The Perry court�s ruling encourages vendors dealing with financially-strapped customers to consider payment by credit card, especially if the vendor senses that the customer may be forced to file bankruptcy. The court�s refusal to find that a credit card payment constituted property of estate, encourages vendors to continue to sell to customers in financial difficulty.

A vendor must address a number of issues prior to accepting credit cards, such as the terms of the merchant contract, credit card software, processing the card, timing of shipments with credit card payments, fraud, privacy issues, chargebacks and the costs of the transaction. However, as noted, accepting credit cards has many advantages, including, now, a potential preference defense.

^1. Scott Blakeley is a principal of Blakeley & Blakeley LLP, where he practices creditors� rights and bankruptcy law. His e-mail is seb@bandblaw. com.

^2. 343 B.R. 685 (Bankr. D. Utah 2005)

^3. 343 B.R. at 688.