#4 Another Thorn in Creditors’ Sides: New Case Makes Preference Payments Easier to Claw Back

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02/03/2011 4:51 PM

A recent case made it harder for an unsecured creditor to defend a preference avoidance action in a bankruptcy.  This ruling may be particularly troubling to unsecured creditors in the construction industry, because it involved the potential for payment from bond proceeds.

The case addresses what is perhaps one of the most painful (to creditors) provisions in the bankruptcy code.  The “preference” provision allows a debtor (or trustee) to “claw back” payments to unsecured creditors made within the ninety days before the bankruptcy filing.  One way that an creditor can resist attempts to claw back the payment is to show that the creditor would have received full payment anyway if the debtor had liquidated rather than filed bankruptcy.  Usually the creditor shows that the debtor had enough assets to pay that creditor’s claim in full, so that the creditor did not receive more by getting the payment than it would have on liquidation.

This creditor carried the concept one step further, arguing that it would have been paid in full from a performance bond posted for the debtor’s construction project.  The creditor argued that it had received no more than it would have received if the debtor had liquidated, because after liquidation the creditor would have made a claim on the bond and been paid in full.  The court rejected this argument, holding that bankruptcy courts should not consider whether the creditor would have received payment from some other source, but should only consider whether the creditor would have received payment from the debtor’s estate, if the debtor had liquidated rather than filed bankruptcy.

This ruling eliminates one defense for a creditor when bankruptcy debtors try to recover payments from a bonded vendor, often months after the payments were made.  Creditors should consult bankruptcy counsel to help implement billing and collection mechanisms that make it more difficult to attack payments received before a debtor’s bankruptcy filing.

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