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The Dreaded Preference Action: How Long Until You Are Safe?

Receiving a notice that a customer has filed bankruptcy is never a good feeling, especially if that customer has been a large component of your business. The initial shock is generally followed by a feeling of unease regarding all of the recent payments you received from that customer and the knowledge that any payment received in the past 90 days may be taken back. So, how long can it take to receive the dreaded preference claim, one year, two years, longer? Unfortunately, the answer is not that clear.

The current wording of the Bankruptcy Code allows for a preference action to be commenced within either two years after the order for relief has been entered (essentially the date the debtor filed for bankruptcy relief) or an additional one year if a trustee is appointed within the aforementioned two year period. This means that it is very possible for a preference action to be commenced close to three years after you have received notice of a bankruptcy filing!

As scary as this may seem, it may not even be possible for you to know when the statute of limitations has started. The scenario that would lead to this seemingly absurd situation is the subject of a circuit court split. In essence courts are unsure whether the appointment or election of a permanent trustee must occur during the original two year statute of limitations in order to be allowed the one year extension, or whether an interim trustee, who becomes the permanent trustee after the two years, would still be granted the one year extension. To clarify using an example, say a Chapter 11 case is filed on June 1, 2013, and it is converted to a Chapter 7 on May 1, 2015. Normally there would be a two year statute of limitation from June 1, 2013, which a preference action must be commenced. However, if the creditors call for and elect a permanent trustee prior to June 1, 2015, then the trustee is granted an additional one year from his/her appointment to bring a preference action. The confusion comes in when an interim trustee is appointed, let’s say, on May 31, 2015, and is judicially appointed as the permanent trustee on August 1, 2015. The majority opinion thus far is that the statute of limitations has run as of June 1, 2015, and no preference action may be commenced thereafter. Some courts however, believe that the trustee should be allowed one year from his/her appointment as interim trustee, meaning that the trustee would have until May 31, 2016, to bring a preference action. This issue has not yet been addressed by North Carolina courts or the Fourth Circuit, so it is unclear which decision will be followed in this jurisdiction.

So, what should you plan for on your books? In the real world preferences tend to settle rather than go to litigation. Two years from the debtor’s filing should be an appropriate time to keep a potential preference action on reserve; thereafter, unless a permanent trustee was elected or appointed, the trustee will have a very difficult time asserting the statute of limitations has not run. Also, it is important to remember that the overarching goal of bankruptcy is an equitable treatment of all parties involved. Therefore, you should not feel totally helpless upon receiving a bankruptcy notice or even a preference action, as there are always defenses and ways to fight to keep what you deserve.

About James Vann

James’ law practice concentrates on creditors’ rights, unmanned aircraft systems, business law and planning and succession, civil commercial litigation, estate planning and business succession planning. Through his family business, James learned at an early age the value of sound business judgment and values. When representing his clients, James strives to consider business and economic issues, as well as the legal issues.
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