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FJP
Delaware Preferences: Successful Defense in a Recent Case
Sometimes people can be
legitimately sued without any wrongdoing: Defendants find
preference actions to be particularly objectionable. In these actions, the
defendant did nothing wrong and is only being sued for the return of payments
because they were made by a debtor in bankruptcy within the 90 days (or 1 year
for insiders) preceding the bankruptcy filing.
Bankruptcy preference actions brought against businesses after a customer
files for bankruptcy can be quite costly. Most times, a business owed money is
not likely to fully recover claims. And preference type suits may actually
require the business to return its customer’s payments. The legal authority for
these actions is found in
section 547 of the Bankruptcy Code, which is part of the United States Code.
The basic theory behind these actions is that they promote greater equality
amongst the general unsecured creditors by preventing the debtor from
“preferring” certain creditors over others during the 90 days (1 year for
insiders) prior to the bankruptcy filing in which the debtor is presumed to be
insolvent and not able to pay all of its liabilities. The debtor legitimately
owes the money that was paid to the defendant, who the debtor or a trustee is
now demanding to be returned to the debtor. In many cases, the defendant is also
still owed on additional invoices that the debtor didn’t pay. However, the
following is an example where the defendant prevailed. Westfield Steel—a steel
supply company based in Indiana—and Elrod Holdings Corp. had business
relationship spanning ten years. Elrod designed, manufactured and installed
spectator seating for racetracks using steel and steel-related materials shipped
from Westfield. During the course of the business relationship both
parties had agreed on billing and payment procedures that entailed Westfield
receiving payment upon the completion of a project, a common practice in the
steel industry. On October 16, 2006 Elrod filed for
Chapter 7 bankruptcy in Wilmington, Delaware. Upon the filing, a
Chapter 7 Trustee was appointed and subsequently the Trustee brought suit
against Westfield based upon a claim that the company received preferential
payments from the debtor within 90 days of filing for bankruptcy and claimed
that approximately $60,000 should be returned. Westfield denied the claim
and asserted among other things that any payments it received were in the
“ordinary course of business.” The basis for recovery of
preferences is to allow equal treatment of creditors and not reward the most
demanding creditor, who may have seized assets just before a bankruptcy filing.
However, there are defenses to preference actions and a principle defense is the
Ordinary Course of Business Exception, permitting a defendant to retain
payments made by a debtor during the 90 days before the bankruptcy filing if the
payments were made in the ordinary course of business or in accordance with
ordinary business terms. This exception balances the interests of the
debtor and creditor and allows businesses to continue as usual even though the
debtor may be in financial distress. It also allows the parties to continue with
the same credit terms without the threat that payments may have to be returned. The ordinary course of
business defense must be presented by the facts and circumstances in each case.
Several considerations must be taken into account before the judge may make a
ruling. Here, both parties agreed on a billing procedure with the understanding
that payment would be accepted between 30 and 73 days of invoicing. And prior to
the bankruptcy Westfield asked Elrod on multiple occasions about several unpaid
invoices (within the 90 days before the bankruptcy Elrod made payments between
30 and 74 days, adding up to approximately $60,000). In this instance, Westfield
and Elrod had been working together for ten years and had a working credit
agreement. Although there was some evidence of collection tactics by the steel
supplier Westfield such as threats to withhold shipments, the parties had
engaged in this practice regularly and the conduct did not rise to the level of
taking advantage of the debtors deteriorating financial condition. Upon receiving the summons
and complaint, Westfield retained bankruptcy counsel who associated with a
Delaware bankruptcy firm. After answering the complaint, and completing
discovery, the defendant filed a
Motion for Summary Judgment to avoid trial and set forth an ordinary course
of business defense. In finding in favor of Westfield Steel, the Bankruptcy
Court dismissed the case and ruled that there was a defense to the preference
claim and Westfield did not have to return the approximate $60,000 of payments.
It is important to note that documentation of the customer relationship may be
vital if the company is sued for a bankruptcy preference (To protect your
interest, you should immediately seek bankruptcy counsel if you are on the
receiving end of such a preference action). The Bankruptcy Code
provides for several other defenses in addition to the ordinary course of
business defense. One of those other defenses is the contemporaneous
exchange of new value defense, where the defendant may not have to return the
payment(s) if they can establish that such payment(s) from the debtor was made
at the same time as the goods (or services) were provided by the defendant. An
example of this involves the parties agreeing to conduct the transaction on a
C.O.D (cash on delivery) basis, prior to the bankruptcy. Another possible
defense is the
subsequent new value defense, where after receiving payments (which turn out
to be preference payments) from the debtor, the defendant continues to provide
additional goods and/or services to the debtor. This situation often
arises when the debtor and defendant had an ongoing business relationship where
the debtor ordered goods and/or services from the defendant on a frequent and
regular basis, like in the case of Miller v Westfield Steel. When
defending a preference action, it is important to seek the advise of experienced
bankruptcy counsel and provide them with all the information requested
to allow
them to determine which defenses, if any, can be asserted.
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