Bankruptcy preference claims are always an unpleasant surprise. They are frustrating and, in many circumstances, are unjust because they allow a bankruptcy trustee or the debtor to clawback money you received in exchange for providing valuable labor, services, or products.

What is a “preferential transfer”?

The elements of a preferential transfer are highly technical.  Here is the basic idea: if you received payments from the debtor within 90 days of the debtor’s bankruptcy filing date and those payments were made on account of antecedent debt, then those payments may qualify as preferential transfers.  Contractors and suppliers are frequently targeted by bankruptcy trustees for such claims.  Fortunately, contractors and suppliers have several defenses, some of which are unique to them.

Primary Defenses

The Texas Construction Trust Fund Act – if the payments were for labor and/or materials furnished to a specific project located in Texas, then the payments should be treated as construction trust funds rather than property of the bankruptcy estate.

Subsequent New Value – if you provided labor and/or materials on credit for which you were not paid and the labor and/or materials were furnished after the alleged preferential transfer, then you may be able to argue the subsequent new value defense applies and bars the preferential transfer in the amount of the unpaid invoice for the subsequently provided labor and/or materials.

Ordinary Course of Business – in order to prove this defense, you must show the debts underlying the payments were created in the ordinary course of business and the payments were either made in the ordinary course of business under your pre-preference period history with the debtor or ordinary with respect to the industry standard.  To analyze this defense, courts look at many factors, including, but not limited to: the timing of the payments, the method of payments, the amount of the payments, and whether collection activities occurred.

C.O.D. (Cash on Delivery) – if the payments are C.O.D. (i.e., made contemporaneous to the delivery of the goods), then the payments should not be a preferential transfer because preferential transfers must be made on account of antecedent debt.

Liens – if you could have filed a lien if you were not paid, then, depending on how encumbered the project is with prior liens, you may be able to negate one of the elements of the preference claim – in particular, that you did not receive more than you would have if the bankruptcy was a chapter 7 liquidation, you were not paid, and you filed a lien.  You may also be able to argue that the payment released your lien and therefore the debtor receive contemporaneous new value.

Jury Trial – This is not so much a defense as it is a procedural right.  If you did not file a proof of claim or otherwise appear in the debtor’s bankruptcy, then you may be able to demand a jury trial and move to withdraw a reference to the district court.

The Importance of Paperwork

The quality of your documentation is key to each of these defenses.  If you get hit with a lawsuit, you will need all relevant documents.  Examples include: contracts, change orders, pay applications, invoices, purchase orders, statements, checks, quotes, delivery tickets and communications related to the payments at issue.

Bottom Line

 If you receive a demand or are sued based on a preference claim, do not write a check just yet.  You may have one or more of the above defenses.  Consult an attorney who is knowledgeable regarding construction law and experienced in defending against these actions.