March 01, 2013

Given the economic turmoil observed across a variety of industries in recent years, the possibility of preference demand letters has been a significant concern for creditors of all types. According to Section 547 of the Bankruptcy Code, after filing for bankruptcy, the trustee or debtor-in-possession may recover transfers occurring in the 90 days prior to the filing, provided the transfers meet certain criteria. Conversely, the creditor has several defenses against preference claims to retain transfers previously received.

In the January 4, 2012 opinion of Honorable Judge Christopher J. Sontchi of the United States Bankruptcy Court for the District of Delaware, a comprehensive assessment of preference law and its underpinnings was provided.1 Judge Sontchi attempts to provide the reader with an economic understanding of why bankruptcy law exists and what equities it is trying to balance. He notes “[t]he basic problem that bankruptcy law is designed to address is that the system of individual creditor remedies, i.e. ‘first come; first served,’ may harm creditors as a whole when there are insufficient assets to pay all of them in full.” He goes on to discuss how preference law specifically addresses this dilemma: “[p]reference law enters the picture because the descent of a company into bankruptcy takes time. This allows the more diligent, individual creditor to opt-out of the compulsory, collective proceeding of bankruptcy by exercising its individual, state law remedies or, at least, by pressuring a potential debtor to pay the creditor’s claim ahead of other claims.”

Bankruptcy law attempts to address this by providing trustees and debtors-in-possession the opportunity to recover from creditors those payments which may have been preferential, as described by Judge Sontchi. In most bankruptcies, the trustee or debtor-in-possession is permitted by law to review any payments (“transfers”) in the 90 days prior to the filing of the bankruptcy.

 

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