Preference Actions in Retail Bankruptcies – Part I

If you are a supplier that has done business with a retailer who files for bankruptcy, amounts owed to you at the date of the bankruptcy filing may only result in a distribution of cents on the dollar.  Unfortunately, it could become worse if you are deemed to have been the recipient of preferential payments within 90 days of the filing.  In Part I of this post, we will discuss the rationale behind why the Bankruptcy Code allows for the recovery of these payments and the requirements for a payment to be considered preferential.

Rationale for Recovery of Preferential Payments

Section 547 of the Bankruptcy Code allows for the recovery of payments deemed preferential for the benefit of the bankruptcy estate.  The rationale for recovering these preferential payments is to ensure that all creditors receive a pro-rata or equitable share of the bankrupt retailer’s assets.  The risk of preferences also helps to discourage the suppliers and vendors of retailers heading towards bankruptcy from pursuing over-aggressive collection efforts.  Preference actions serve the Bankruptcy Code purpose to ensure an equitable distribution of the bankrupt retailer’s assets between all unsecured creditors.

Requirements for a Payment to be Preferential

To be successful in recovering a preferential payment, Section 547 of the Bankruptcy Code requires that the Debtor or Trustee satisfy the following requirements, which involve proving that the alleged payment was:
  • A transfer of an interest of the debtor (retailer) in property (typically in the form of a check or wire transfer),
  • Made to or for the benefit of a creditor (supplier or vendor),
  • For or on account of an antecedent debt (the debt had to be incurred before the allegedly preferential transfer),
  • Made while the debtor (retailer) was insolvent (assumed to be within 90 days of the bankruptcy filing date), and
  • Resulted in the payee receiving more than it would have received in a hypothetical Chapter 7 or liquidation.
Suppliers to retailers are frequently the target of preference actions after the retailer files for bankruptcy.  Since the Debtor or Trustee has two years after the date of the bankruptcy filing to file preference actions, they can pop up just as you thought the worst was behind you. For example, in November 2010, within two years of the Circuit City bankruptcy filing, the Trustee for the Circuit City Stores Liquidating Trust filed more than 500 lawsuits seeking recovery of alleged preference payments.

In the second part of this post, we will discuss how retail suppliers can protect themselves from potential preference exposure and certain defenses that a supplier can utilize to defend alleged preference payments.