The Danger of Preference, and I’m Not Talking About Taste

Provided by Gary Wassner for CFDA “From the Experts”

 

In the midst of today’s turbulent retail environment, the last thing in the world any manufacturer would want to have happen is to find out, after you’ve been paid by a store for merchandise you shipped according to their order, on time and without any dispute after shipping, that the payment is being recalled from you by a bankruptcy trustee. You’d have no choice but to return the funds you received if the trustee is claiming Preference, even if you were paid 90 days before the store filed for bankruptcy.
Provided by Gary Wassner for CFDA “From the Experts”

 

In the midst of today’s turbulent retail environment, the last thing in the world any manufacturer would want to have happen is to find out, after you’ve been paid by a store for merchandise you shipped according to their order, on time and without any dispute after shipping, that the payment is being recalled from you by a bankruptcy trustee. You’d have no choice but to return the funds you received if the trustee is claiming Preference, even if you were paid 90 days before the store filed for bankruptcy.

 

Preference recoveries are frustrating and dangerous, and seem terribly unfair, but they are designed to protect all the general creditors when a company files for bankruptcy. They are not designed to hurt the creditor who was paid early for the merchandise they shipped, even though it may often seem so.

 

So, what is preference and why should you, as a manufacturer/designer be concerned about it? Moreover, what can you do to protect yourself from being the victim of a preference claim?

 

I’m not a lawyer, so I’m going to try to translate the Bankruptcy code into laymen’s terms, and thanks to an article written by Bruce Nathan, Esq, a partner at Lowenstein Sandler PC and an associate and friend, this task will be much easier. Section 547B of the Bankruptcy code allows a trustee in charge of the assets of the bankrupt to recover previous payments under the following circumstances:

 

a) The debtor transferred its property, such as making payment, to or for the benefit of a creditor;

 

b) The transfer was made on account of the antecedent or existing indebtedness that the debtor owed the creditor;

 

c) The transfer was made when the debtor was insolvent. A balance sheet definition of insolvency, liabilities exceeding assets, is used. The statute also makes it easier for a trustee to prove a preference by creating a presumption of the debtor’s insolvency within the 90-day preference period;

 

d) The transfer was made within 90 days of the debtor’s bankruptcy filing, in the case of transfers to non-insider creditors, and within one year of the bankruptcy for transfers to insiders of the debtor, such as the debtor’s officers, directors, controlling shareholders and affiliated companies; and

 

e) The transfer enabled the creditor to receive more than the creditor would have recovered in a Chapter 7 liquidation of the debtor. This requirement is always satisfied unless the debtor’s unsecured creditors receive full payment of their claims.

 

What does this all mean? It means that if you ship a store on time, a store you’ve done business with before and may even have open invoices with at the time you ship them again, and then subsequent to delivering the merchandise, you fear that they are in financial trouble and you therefore request that they pay you earlier than the terms of the invoice, whatever they pay you will be subject to a recovery by the trustee if the store does file for bankruptcy within 90 days of that payment and meets the rest of the criteria above. You may think you’ve saved yourself from a loss, when in fact you have not at all. Once the store files, the trustee will examine all the payments made within the previous 90 days. If your payment is one of those, it may be recalled and you’ll have no choice but to return it to the trustee.

 

How can you protect yourself from this? If you’re factored and the invoice was approved by your factor, the preference claim would be levied against your factor and not you. The factor would suffer the loss and be required to present the defense. If you were paid according to the terms of the invoice and those terms are your usual and customary terms with the store, you’ll have an opportunity to demonstrate that to the court and you will ultimately recover those funds. But it will be incumbent upon you to demonstrate that this payment was made as an ‘Ordinary Course of Business’ transaction.

 

The best way to protect yourself from what seems like a slap in the face to the least responsible party is not to ship any stores that have poor payment histories, that are not approved by your factor for poor payment histories (if you’re factored), who don’t cooperate with the credit community in general, or who are poorly rated by a credit service such as D & B. Don’t think because you are friends with the buyer or the owner or the fashion director, that they can help you get paid early in the event the store runs into financial difficulty. Even if they can, those payments will most likely have to be returned long after you thought the entire episode was over and you escaped a credit loss. Another way of protecting yourself from a credit loss if you are concerned about the financial health of a store is to demand a pre-payment if that store wants your merchandise so badly. Pre-payments are not subject to recall by a trustee, since preference only applies to antecedent debt and pre-payments presume there is no antecedent debt.

 

I can’t tell you how many times I’ve heard clients tell me that they know the owners of certain stores so well, and they know that those people would never hurt them. Even if they have no intention of hurting you, they have no choice when it comes to bankruptcy and preference. So don’t fool yourself. You cannot elude the recall of payments made to you if they were paid earlier than another creditor was paid who shipped under the same terms of sale, or if they were not paid according to the usual and customary terms under which you shipped this same store and were paid by them previously. Don’t be naive. Don’t be led astray by promises. If you understand the Bankruptcy code relating to preference, you can avoid this totally unforseen nightmare from happening to you.

 

By Gary Wassner / President / Hildun Corporation / gary@hilldun.com / www.hilldun.com

 

If you have any further questions, please feel free to contact Gary via email.