Preference Claims - Why the last 90 days of transaction history matters?
Bankruptcy filings by a single construction project participant can lead to a chain reaction, causing financial distress for other participants and disruption of payment systems and completion schedules. The ‘automatic stay’ injunction that goes into effect upon filing for Chapters 7, 11, or 13 bankruptcy prevents collection agencies and creditors from demanding payment.
The debtor or a court-appointed trustee can demand the return of all payments made in the 90-day period before the bankruptcy filing, referred to as "preference demands." Basically this 90-day forward movement of the effective insolvency date is trying to set all creditors equal and eliminate the benefit of early knowledge of the issues. Project participants not involved in the bankruptcy still may be subject to the trustee ‘clawing back’ partial payments received by other contractors, subcontractors, or suppliers from the debtor. However, non-bankrupt project participants have several defenses available to reduce or eliminate liability in preference demands.
Bankruptcy trustees often use preference claims as a way to retrieve funds that can be used to pay creditors in a more even distribution. If the payments were made to an "insider" such as a family member of the debtor's owners or certain business affiliates, the standard 90-day preference period is extended to one year. This is based on the policy that a debtor should not be allowed to favour one creditor over another.
While the Bankruptcy Code recognizes that payments within the 90-day preference period were not always preferential, there are various defenses that can be raised to a preference demand. The most common of these are the ordinary course of business defense (payments were made according to the historical practice of the parties) and the new value defense (after receiving the preference payment, the non-debtor provided new goods or services to the debtor, offsetting the preference payment). However, these common defenses can be subjective in nature, and they rarely convince the trustee to fully drop its preference demand.
There are additional defenses available to non-debtor project participants that, in certain circumstances, may result in an objective defense that no liability exists in connection with a preference demand. For example, the non-debtor may be the holder of a statutory lien right in association with its contractual project obligation to provide labor, materials, or services related to the debtor contractor, as well as the non-debtor's right to receive payment. In these instances, any attempt to claw back the alleged preference payments is considered at odds with mechanic lien law and bankruptcy law principles, and as such rejected.
Take-Away - What’s the lesson from all this?
In order to assess the risk profile of your claim, buyers will need to understand the activity from your account over the last 90 days prior to the Company filing for bankruptcy. That’s why we recommend screenshotting and downloading all transaction data as soon as possible after insolvency rumours come to light. We further recommend keeping automated transaction emails enabled and not delete them - they can be a valuable form of back-up for buyers’ due diligence.
And obviously, if any questions remain or you are struggling to reconcile your account activity, please reach out to us!