Avoid unwanted exposure: creating a defense against preference payments.(extra credit)

For any business, there is almost nothing more frustrating than when they receive notice that a debtor is seeking repayment of a preference. It's as if the whole process of trying to collect on a delinquent account was all for naught.

According to Robert Mercer of Powell Goldstein LLP, the process for a company trying to protect itself from preference and fraudulent transfer exposure can be a tightrope walk. There must be balance between what makes the most business sense for the grantor's firm, while not destroying that firm's access to powerful tools like the ordinary course of business defense.

"There is one thing that I have learned from representing trade creditors and that is the absolute frustration of dealing with fraudulent transfers and preferences," Mercer told attendees during "Preferences and Fraudulent Transfers: The Basics and Beyond" an NACM audio teleconference.

A preference is a payment from a customer on an existing debt during the 90 days before the customer files bankruptcy, provided that the customer is insolvent at the time of the payment. Fraudulent transfers, a little more uncommon, are payments from any entity other than the company's customer at a time when such an entity is insolvent, such as when a corporate affiliate of a customer pays that customer's invoice. In either case, the ultimate goal is maintaining a "business-as-usual" course.

"The first thing is, when looking at the payments that were received during the 90 days before your customer filed for bankruptcy, you want to see if those payments were consistent or were ordinary when you compared them with the historic payment pattern before your customer filed for bankruptcy," said Mercer. "The main focus is how many days after the invoice day do you normally receive payment."

The recent change in the Bankruptcy Code has made it substantially easier for firms to protect themselves against preference and fraudulent transfer exposure. If a customer's underlying bankruptcy was filed on or before October 17, 2005, to establish an ordinary course of business defense, a firm had to prove that the payment received in question was "ordinary" in respect to the customer's historical payment pattern and with that of the relevant industry. Now, firms just need to prove one of those elements, with 95% of cases decided by the first-mentioned prong.

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