Q: I recently got a letter from the bankruptcy court demanding that I return money my customer paid me right before filing for bankruptcy. Can they do this? I’m still owed money. What should I do?
A: You just became a member of the “double whammy” club. Not only do you have little expectation of future payment of your balance, but you are actually being told you have to return the money you were already (and probably rightfully) paid. You have received a demand to return a “preferential transfer,” the purpose of which is to recoup payments that allowed a creditor (you) to supposedly get an advantage a short time before the bankruptcy case was filed.
Not every preference demand is legitimate. Take a careful look at the deadline for returning the payment, and, if necessary, get an extension. You may have defenses against returning the money. The burden is on the bankruptcy trustee to prove that the payment should be returned under the law. Even if the demand is legitimate, you could still have a “subsequent new value” or “ordinary course of business” defense or there may be opportunities to reduce the amount. In any case, you owe it to yourself to thoroughly investigate your options before handing over a check.
Q: I have a customer who has filed for bankruptcy under Chapter 11. Even though my company is a secured creditor, I have just been informed that some unsecured creditors are receiving priority payment in the bankruptcy proceedings. Isn’t this contrary to the letter and spirit of the Bankruptcy Code?
A: Some unsecured creditors are turning the neatly arranged bankruptcy rules on their head. The unsecured creditors have likely invoked the Necessity of Payment Doctrine, also called the Rule of Necessity, and been designated Critical Vendors. Critical Vendors are unsecured creditors who provide goods and services that are critical to the bankrupt business getting back on its feet. The Rule of Necessity says that because rehabilitating a struggling business is the fundamental purpose of Chapter 11, the courts can look first at which creditors are essential to the bankrupt’s business. They get paid first to avoid a disruption in service. Other creditors with greater or equal priority interest just have to wait in line and hope there is something left over for them. Therefore, it is crucial to keep tabs on bankruptcy proceedings from the start in order to protect your interests.