How to Protect Yourself From a Customer Close to Bankruptcy

MarketWatch had a very gloomy headline last week: More Tribunes, Lehmans likely in coming months. The truth contained in that headline makes it even gloomier.

Considering the talk - if not the pushing - of the Big three Automakers towards bankruptcy court, this drive towards bankruptcy seems likely. I am on the side of those who think the bankrupting the Big Three is a dangerous idea. Unlike service industries (and those being financial services and newspapers) and even unlike the favorite of television pundits, the airlines, these manufacturers have a long chain of suppliers.

What worries me is what is called preferential transfers. Put simply, money paid to a creditor within 90 days of filing a bankruptcy can be disgorged from the creditor. Which means the creditor gives back money owed to it and which was probably need to pay its own creditors. The statute is 11 USC 547 and reads as follows:

(b) Except as provided in subsections (c) and (i) of this section, the trustee may avoid any transfer of an interest of the debtor in property—

(1) to or for the benefit of a creditor;

(2) for or on account of an antecedent debt owed by the debtor before such transfer was made;

(3) made while the debtor was insolvent;

(4) made—

(A) on or within 90 days before the date of the filing of the petition; or

(B) between ninety days and one year before the date of the filing of the petition, if such creditor at the time of such transfer was an insider; and

(5) that enables such creditor to receive more than such creditor would receive if—

(A) the case were a case under chapter 7 of this title;

(B) the transfer had not been made; and

(C) such creditor received payment of such debt to the extent provided by the provisions of this title.

The statue also sets out what transfers cannot be set aside:

c) The trustee may not avoid under this section a transfer—

(1) to the extent that such transfer was—

(A) intended by the debtor and the creditor to or for whose benefit such transfer was made to be a contemporaneous exchange for new value given to the debtor; and
(B) in fact a substantially contemporaneous exchange;

(2) to the extent that such transfer was in payment of a debt incurred by the debtor in the ordinary course of business or financial affairs of the debtor and the transferee, and such transfer was—

(A) made in the ordinary course of business or financial affairs of the debtor and the transferee; or
(B) made according to ordinary business terms;

(3) that creates a security interest in property acquired by the debtor—

(A) to the extent such security interest secures new value that was—

(i) given at or after the signing of a security agreement that contains a description of such property as collateral;
(ii) given by or on behalf of the secured party under such agreement;
(iii) given to enable the debtor to acquire such property; and
(iv) in fact used by the debtor to acquire such property; and

(B) that is perfected on or before 30 days after the debtor receives possession of such property;

(4) to or for the benefit of a creditor, to the extent that, after such transfer, such creditor gave new value to or for the benefit of the debtor—

(A) not secured by an otherwise unavoidable security interest; and
(B) on account of which new value the debtor did not make an otherwise unavoidable transfer to or for the benefit of such creditor;

(5) that creates a perfected security interest in inventory or a receivable or the proceeds of either, except to the extent that the aggregate of all such transfers to the transferee caused a reduction, as of the date of the filing of the petition and to the prejudice of other creditors holding unsecured claims, of any amount by which the debt secured by such security interest exceeded the value of all security interests for such debt on the later of—

(A)

(i) with respect to a transfer to which subsection (b)(4)(A) of this section applies, 90 days before the date of the filing of the petition; or
(ii) with respect to a transfer to which subsection (b)(4)(B) of this section applies, one year before the date of the filing of the petition; or

(B) the date on which new value was first given under the security agreement creating such security interest;

***
(9) if, in a case filed by a debtor whose debts are not primarily consumer debts, the aggregate value of all property that constitutes or is affected by such transfer is less than $5,000.

When I lat researched this kind of case a few years back I found cases where even the Internal Revenue Service lost to the bankruptcy trustee.

I also came to a very firm opinion that without proper preparation by the business owner, even the best lawyer will lose these cases without the assistance of pure, blind, dumb luck. When a business' debtor appears close to bankruptcy the business must get its attorney in for a consultation on how to deal with the potential bankruptcy. Waiting till getting the bankruptcy notice is too late. Counsel needs to see what is owed, what is the subject of the debt and needs to work on getting the debt into the category of a non-preferential transfer.

Returning to the larger picture, I assume GM's (or Ford's or Chrysler's) suppliers have made what will turn out to be preferential transfers which will be forced from their creditors and those creditors will moving towards bankruptcy court themselves. And then their creditors. Just like a row of dominoes they may all be heading to bankruptcy court.

I suggest every business needs to sit down with counsel who has knowledge of bankruptcy. For those with Indiana businesses, please feel free to give me a call.