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.
4 W. Market St.
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.