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Business Law

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Q: One of the customers of my company filed for bankruptcy and I received a letter from the customer’s bankruptcy attorney demanding that I return all payments I received from the customer during the 90 days prior to the bankruptcy filing. Can he be serious? The customer never complained about any of the services that we provided them and we earned the money. Why should I have to pay it back?

A: Sadly, the letter is not a joke. The short answer to your question is that you may have to return the payments you received in the 90 days prior to your customer’s bankruptcy. However, you may have defenses to your customer’s demand and you should not return any payments to your customer until you consult with a bankruptcy lawyer who can determine if any of those defenses apply in your case.

The payments you received are called “preferences." Under the Bankruptcy Code, a Debtor (the person or entity that files for bankruptcy), or the Trustee for the Debtor, if one is appointed, can seek to recover all payments made by the Debtor to creditors during the 90 days prior to the Debtor’s bankruptcy filing if those payments were made on account of a debt owed by the Debtor before the payment was made. It does not matter whether or not you were entitled to the payment or there is an issue regarding the services performed by the Creditor.

However, don’t despair. There are many defenses to preference claims that may be available to you. The most common defenses include: (a) the payments to the your company are not preferences because they were not made on account of an “antecedent debt”, i.e. they were advance payments or C.O.D. payments; (b) the debt was secured by a security interest in the Debtor's assets or you hold a valid right to set off an equal or greater amount you owed to your customer; (c) the payments were made in accordance with the “ordinary course of business” of your firm and the Debtor (i.e. on the usual terms, in the usual time and by the same method as your firm and the Debtor have conducted business in the past); (d) the payments were made in accordance with ordinary business terms in your industry (i.e. on the usual terms, in the usual time and by the same method as business is normally conducted in your industry); (e) you provided goods or services to the Debtor on credit in-between the time when you received the allegedly preferential payments and the Debtor filed for bankruptcy; and (f) the Debtor was in fact, not insolvent at the time of the payments. There are less common defenses that may also be available to you.

There are many technical requirements that will determine whether or not these defenses are available to you.