Smaller creditors also usually don’t have a good defense to a preference suit, in which the burden of proof is on them. For example, in the “ordinary course” defense, the vendor has to prove that the credit terms extended to the insolvent company in the prebankruptcy period were consistent with the way the two normally conducted business. “The best defense is consistency,” says Schaeffer. “If the numbers are inconsistent, you will lose every time.” The problem is that small companies selling to large companies often bend over backward to keep the business, to the point of loosening credit terms to customers on the brink of insolvency.
Other preference-claim defenses provide small companies with some measure of protection. Under the “new value” defense (Section 547(c)(4) of the Bankruptcy Code), if the creditor shipped another order or supplied services to the debtor after it received the payments that the bankruptcy trustee is seeking to recover, the creditor can offset the preference claim by the value of the new order or services.
Finally, the BAPCPA established a new protection to suppliers that ship goods to insolvent companies in the period right before a bankruptcy filing. These “reclamation claims” (Section 503(b)(9)) award first priority, administrative status to claims by creditors that ship the insolvent company goods within 20 days of the bankruptcy filing. Administrative claims have to pay 100 cents on the dollar before other unsecured creditors see a dime.
Charging that the preferences section of the Bankruptcy Code leads to “abusive preference recovery suits,” the National Association of Credit Management is petitioning Congress to change the code. It is “common practice for trustees,” the NACM says, “to send out a blanket demand and complaint to every creditor who received payments within 90 days of the bankruptcy filing,” and they do so with “little or no prior investigation other than to review the debtor’s check register.” It’s rarely cost-effective for the creditor to defend against the action, the NACM contends.
The NACM also says a study by the National Bankruptcy Review Commission found that more than 90% of preference recoveries are not dedicated to satisfying the needs of unsecured creditors but instead go to funding recovery activities.
Of course, the best defense to the risk of being sued in a preference action is to keep customers on a regular payment schedule. “If a customer has been paying net 45 [days] on average and they start slowing down, you have to pull back on the reins and get them back into the 45-day area,” says Schaeffer. “The finance department that is more alert to customers’ financial problems and treats all customers the same reduces its exposure to [bankruptcy risks].”