For most creditors, word that one of their credit account customers has filed for bankruptcy protection under Chapter 7 of the United States Bankruptcy Code creates a sense of apprehension. It is common knowledge that payments received from the customer within the 90-days immediately preceding the filing of the bankruptcy petition are subject to review by the trustee. All creditors, at one time or another, have received a letter from a trustee indicating that a payment appears to be a preferential payment and requesting that the money be returned.

WHAT CONSTITUTES A PREFERENTIAL PAYMENT?

The criteria provided by the Bankruptcy Code for what may be avoided by the trustee as a preference is simple.

1. If a creditor received a payment or other form of interest in property belonging to the debtor on a past due account within the 90-days prior to the filing of the bankruptcy petition.
2. The trustee believes that the payment or transfer will result in the creditor getting more than its appropriate share of the bankruptcy estate, then the trustee is obligated to attempt to recover the amount of the transfer.

HOW LONG MAY A TRUSTEE WAIT TO BRING AN ACTION FOR A PREFERENCE?

It would seem as if the answer to this question should be simple, however, the Bankruptcy Code makes it complicated. The best way to approach this issue is in the form of a mathematical problem.

A. First, it is necessary to determine which of two events occurred later in time:

1. Two years after the entry of the order for relief – this order is issued and entered by the Bankruptcy Court upon the filing of either a voluntary or involuntary petition for bankruptcy protection; or
2. One year after the appointment or election of the first trustee (if this appointment or election occurs before the two years in paragraph (1) has expired).

By way of example, if the order for relief for debtor A was entered on January 1, 1999, and for some reason the election or appointment of the first trustee did not occur until December 30, 2000, then the “later” of the two events would occur on December 30, 2001, i.e. one year after the appointment of the trustee. If you change the date of the appointment of the trustee to January 2, 2001, then the operative date would be January 1, 2001, because the trustee’s appointment would have occurred after the two year time limit had expired.

Simply put, if the first document you receive from the Court identifies a trustee, then most likely the two-year period will apply.

B. The second phase of the equation involves the date on which the bankruptcy is closed or dismissed. Note that it is not the date of discharge. Once you determine a date for Section A and a date for Section B, then determine which date is earlier. The earlier date is the deadline for which a preference claim may not be started.

SUMMARY

For all the complicated formula, a rule of thumb would be to remember that the trustee cannot bring an action to recover an alleged preference payment three years after the bankruptcy petition is filed, unless the Bankruptcy Court dismisses the bankruptcy or closes the file.

An important aspect to remember concerning alleged preference claims is the possibility that you may have valid defenses available to you. These defenses may help protect you and provide you with the safeguards needed not to be forced to pay the alleged preference to the bankruptcy court.