Preference Actions in Retail Bankruptcies – Part II

In Part I of this post, we discussed the rationale behind why the Bankruptcy Code allows for the recovery of preference payments and the requirements for a payment to be considered preferential. In the second part of this blog, we will discuss certain defenses that a supplier can use to defend alleged preference payments and how retail suppliers can protect themselves from potential preference exposure.

Defenses to Preference Actions

Vendors and suppliers are able to raise several defenses to avoid having to return funds received in the 90 days before the retailer’s bankruptcy filing.  The purpose of these defenses is to encourage vendors and suppliers to continue to conduct business with the financially distressed retailer in the hope that a bankruptcy filing can be avoided.  The most common defenses to a preference are contemporaneous exchange for new value, subsequent new value and ordinary course of business.
  • Contemporaneous Exchange for New Value:  If the retailer and supplier intended for the payment to be in exchange for new value given by the supplier to the retailer, the payment is not a preference.  Cash on delivery is an example of a contemporaneous exchange.  However, a supplier that requires payment of an outstanding invoice as a condition for shipping cannot use this defense.
  • Subsequent New Value:  New value is generally defined as new goods or services provided to the retailer. If this new value was provided to the retailer subsequent to the date of the preference payment, the amount of new value provided can be offset against the preference amount demanded, thereby reducing the supplier’s preference exposure.
  • Ordinary Course of Business:  The retailer may not avoid a transfer to the extent that such transfer was in payment of a debt incurred by the retailer in the ordinary course of business or financial affairs of the retailer and the supplier. This defense requires that the transfer was made in the ordinary course of business or financial affairs of the retailer and the supplier, (the ‘subjective’ test), -OR- be made according to ordinary business terms, (the ‘objective’ test).

How to Protect from Preference Exposure

Suppliers and vendors can take a proactive approach to reduce the likelihood of becoming the target of a preference action by:
  • Closely monitoring the financial status of their customers,
  • Being diligent about collecting payments in a timely and ordinary fashion,
  • Properly preserving the supporting paperwork for each transaction, and
  • Applying new payments to goods or services provided at the time the payment is made as opposed to outstanding invoices.

Suppliers and vendors should be aware of the strategies noted above to minimize the risks of preference claims and investigate all available defenses if you are sued for alleged preference payments.  For larger claims, creditors should seek the assistance of bankruptcy professionals to help them respond aggressively to the preference demand.

What other strategies have you used to defend against preference exposure?