Pay day is a very happy day. However, the opposite is true of the day a court orders you to pay back money to the trustee in bankruptcy because the customer filed for bankruptcy shortly after you received payment. As discussed in the previous post, it is important to be careful when dealing with cash-strapped businesses. Payments that are out of the ordinary may very well be classified as preferences subject to recovery by the trustee. By following the guidelines below, you may be able to identify problems early and prevent a preference classification.
Keeping it ordinary
The first issue is timing. If a debtor's payments being arriving earlier or later than normal, it is possible that a bankruptcy court may determine that these payments were made outside of the ordinary course of business. Therefore, if your debtor's payment schedule starts to change, it would be wise to find out why and address related issues early.
The second issue is the method of payment. A change in the debtor's method of paying may also signal to the bankruptcy court that payments fall outside the ordinary course. For example, if the debtor usually pays by check but suddenly begins paying by cash, or vice versa, that may provide grounds for denying the ordinary course defense.
The third issue is the amount of the payments. In essence, a court may consider whether the debtor is paying invoices in whole or in part when determining ordinary course status. Beware when a debtor who usually pays invoices in full beings paying only part of the balance. These payments may be deemed outside the ordinary course and thus subject to recovery by the trustee.
The fourth issue is terms of payment. A change in payment terms may indicate to a court that payments are outside the ordinary course. If the debtor requests a change in the terms of repayment, determine why it is requesting the change. If the debtor is seeking the change because of financial difficulty, then this may be grounds for the court to deny the ordinary course defense.
The fifth and final issue is regarding collection practices. In deciding whether paymets are in ordinary course, the bankruptcy court will also look to the collections methods used. Changes in collection practice could put payments outside the ordinary course. Although it may sound counterintuitive, you should thus avoid using extreme or "unusual" debt collection practices when dealing with a troubled company. Doing so could put whatever payments you do receive outside the ordinary course, thus subjective them to recovery as preference.
As more companies file for bankruptcy due to the depressed economy, actions to recover preferential payments will rise accordingly. There are no quick or easy fixes that would restore the economy to the prosperity of the late 1990s and early 2000s, but following the above guidelines when dealing with troubled companies will help your business preserve a defense against potential preference actions.
The idea is to make sure that someone else doesn't get to leave the playground with your toy.© 2014 Varnum LLP