Posted December 21, 2016
By Larz Soper
In the past two blogs, changes in market conditions and the associated increasing risk in the retail sector were addressed. Certainly, the unrelenting pressure to increase sales pushes companies into difficult decisions as they seek to define “acceptable” risk.
We can acknowledge that it is “getting tougher out there” but what can you do if one of your customers files for protection under bankruptcy statutes? Going a step further, if you sense one of your customers is about to file, what can you do to ensure that at least your company gets paid?
Since the world of bankruptcy operates with its own set of statutes and regulations, I sought the insight of a legal professional who specializes in bankruptcy and creditor rights – Lisa P. Sumner. Lisa is a partner with Poyner Spruill, the Raleigh, N.C.-based law firm whose practice is primarily focused on bankruptcy and creditor rights law. Consistent with the topics of previous blogs, Lisa confirmed that there is growing speculation among bankruptcy professionals that the retail sector will experience increasing financial distress in 2017.
Coupled with the significant bankruptcy filings in the retail segment this year, including companies “too big to fail” such as Sports Authority, Eastern Mountain Sports and Bob’s Stores, to name a few, understanding bankruptcy law and creditor rights is imperative.
If you are like many companies, you believe that your company has taken the appropriate steps to effectively manage credit risk. All payments are monitored to prevent any customer from falling more than 30 days past due without having credit sales suspended. Additionally, credit limits are consistently managed so that no unsecured account can result in a loss that would significantly impact the financial viability of your company. If you are consistently doing all of these and as well as protecting your receivables with appropriate credit insurance, you are one of a very prudent few. You have everything covered, right?
Unexpectedly, a large company to which you routinely sold $100K per month and had “always paid like clockwork according to terms” files for bankruptcy with an unpaid balance owed to you of $100K. While the $100K loss is disappointing, it isn’t devastating because your company was prepared for such an occurrence. The proof of claim gets properly filed; your balance you are owed is confirmed; it is now just a matter of waiting to see if you will receive a distribution from the settlement for unsecured creditors. You’ve taken the right steps and you’re out of the woods, or are you?
There always seems to be a catch and this situation is no exception. To evenly protect all unsecured creditors, Section 547 of US Bankruptcy Code, provides for the filing of a Preference Claim. A preference claim, also referred to as a “claw back” claim, permits the bankruptcy trustee to avoid and/or recover payments made within 90-days before the actual bankruptcy filing if those payments represented preferential treatment to one or a few creditors over other unsecured creditors.
That’s right, it is conceivable that your $100K loss could become a $400K loss. To make matters even more stressful, again per Lisa Sumner, the debtor or trustee has up to two years from the date of the bankruptcy filing to file preference lawsuits. Such lags between the bankruptcy filing itself and the preference claim, Lisa went on to say, are common and can lull an uninformed unsecured creditor into thinking there will be no further claims against them resulting in the all top common records purge.
“Big mistake,” Sumner says, “Preserve all records related to those payments for at least two years after the petition date. These records will be critical to analyzing potential defenses to a preference claim, which might not be asserted until much later.”
Uninformed action can make matters even worse. A few years ago, a client was faced with a preference claim demand letter more than one year after the initial bankruptcy filing. Contrary to the advice he was given, the CEO immediately called the trustee directly to settle the claim. The claim was settled for less than was demanded and the CEO bragging about his success in quickly settling the claim for “less” without “wasting money” by engaging an attorney.
What he should have considered was the legitimacy of the preference claim itself and the actual amount, if any, that was legitimately owed. This is an example of spending five dollars to avoid paying one dollar – a far too common mistake.
Sumner explains that a common mistake business make when they receive a preference demand letter is they immediately accept some liability.
“Preference demand letters are sent out to everyone who received a payment from the debtor within the last 90 days rather than spend the time to study legitimate preferential payments,” she said. “Those payments received with legitimate defenses are included. For example, if a debtor mailed a check as prepayment for goods during the preference period, this would not be a preference, but the debtor’s record of outgoing checks wouldn’t flag the check as a prepayment, so a demand letter is likely to be sent.”
As the stability of the retail sector continues to deteriorate, bankruptcies will increase and, as a result, preference claims will follow suit. In such conditions, it is important to keep cool, be patient and explore your options. Lisa P. Sumner put it best, “Preference demands are one area where it pays to consult with counsel with bankruptcy-specific expertise.”
For more answers to this critically important question or any others you may have, please contact Larz Soper, Expert Credit Advisor, at ToYourCredit@sopermail.com.
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Preference claims – patience and professional advice
