D-D-D-Defense Against The Clawback Of Preference Transfers

If one of your customers files for bankruptcy, you can assume that any money they owe you is long gone. If you get paid back anything at all, it will be much delayed and probably pennies on the dollar. That is a well-known risk of doing business without asking for cash on delivery.

A less well-known risk is that money customers pay you will be clawed back if they file for bankruptcy. Payments received from someone who filed bankruptcy less than a year after making that payment to you may be considered “preference transfers.” The bankruptcy trustee can demand that you return such payments to the bankruptcy court so it can determine if you were given preferential treatment by your customer — in other words, getting paid when others were not.

There are several ways to defend yourself against the clawback of a preference transfer, and we have helped our Milwaukee area clients use all of them.

Why Does This Law Exist?

It seems unfair that a business should be punished just because one of its customers has filed for bankruptcy, but the law was actually drafted to combat unfairness. The clawback provisions are intended to prevent some creditors from being treated better than others. Under the law, all of a bankrupt business’ creditors are supposed to be treated equally.

It Still Seems Unfair

If your business is one that got paid and is being asked to give back money that is rightfully yours, you might not agree that the law promotes fairness. Fortunately, there are exceptions to the clawback rule that you may be able to take advantage of. The three most common are (1) the contemporaneous exchange for new value, (2) the subsequent new value and (3) the ordinary course of business defenses.

(1) Contemporaneous Exchange for New Value

Perhaps the most common defense is the contemporaneous exchange for new value defense. It applies when the payment sent to a creditor was intended by both the debtor and creditor to be a contemporaneous exchange for new value, which can include goods, services, credit, or the release of property previously transferred. The important thing is that the money paid was in exchange for something new. The money cannot have been exchanged in order to pay off old debts.

Organizations doing business with debtors who are in financial trouble should make it clear in their bookkeeping that money coming in is being exchanged for something new of value, not paying off past due invoices.

The law works like this because it wants to incentivize companies to keep doing business with troubled organizations in hopes that they can turn things around rather than be forced into bankruptcy.

(2) Subsequent New Value

This defense is only slightly different from the previously discussed defense. In order to claim the subsequent new value defense, the creditor must have given something of value to the debtor after a payment from the debtor was received. Once again, this exception was drafted in order to incentivize the continuation of business relationships in situations where the creditor could easily have been pushed into bankruptcy sooner.

(3) Ordinary Course of Business

This defense applies when the payment subject to clawback was received in the ordinary course of business between the creditor and debtor. In order to take advantage of this defense, the creditor must be able to show that its relationship with the debtor did not change in the time period leading up to the debtor’s bankruptcy filing. No special payments were received, things were just going along like they usually did.

Experience You Can Trust

Our firm has helped many Milwaukee area businesses take advantage of these and other exceptions to the preference transfer law. In our experience, the sooner a creditor acts after being notified of a potential clawback the better. However, it is never too late to try and protect the money you are rightfully owed from flowing into someone else’s pocket. Whether you have just been notified your business was doing business with someone who has filed for bankruptcy, or you have already been asked to return a payment flagged as a preference transfer, don’t hesitate to contact our office and find out what your options are.