Protections befiore your customers go bankrupt r#,ff*b:!tr

II'ALFWAY through a long job for Ilwhich you are supplying materials, you begin to wonder if your subcontractor customer might file bankruptcy before the job is finished. But the job is finished, and you breathe a sigh of relief when you receive the last payment.

Three weeks later. the subcontractor files for bankruptcy. You feel lucky that you were paid and need not worry about collecting your money.

Then months or even years later, you receive a complaint alleging the payments you received in the 90 days before the bankruptcy petition was filed are voidable as "preferential payments." The complaint demands that you pay back the money. After recovering from your shock and dismay, you consult your attorney.

Your attorney tells you that since 1898, federal bankruptcy statutes have provided that the bankruptcy trustee is entitled to recover payments made within the 90 days before the petition is filed if certain conditions are met. He explains the public policy behind such statutes: creditors who are lucky enough to be paid shortly before the banlcruptcy petition is filed should be required to return the payment so the "pot" can then be divided with "equal" treatment to all creditors.

The attorney adds that the trustee's recovery of such preferential payments rarely benefits unsecured creditors as the money recovered usually is paid on bankruptcy priority claims, such as those for administrative expenses, secured clairns and taxes.

Materialmen have three basic defenses to preference claims: preserving their bond and lien rights against third parties by sending the necessary notices, giving appropriate lien waivers, and arranging to have payments made by the owners or general contractors when the financial stability of the subcontractor is in question.

The first defense is that the payment to you was made in the ordinary course of business. The burden of proof is on the creditor who has received the payment to show that the money was paid more or less when it became due under the contract between the creditor and the debtor. There is no hard and fast rule of how many days late a payment may be made and found to be one within the ordinary course. Often a financially weak debtor may begin to make pay-

Story at a Glance

Money you collected before a customer declared bankruptcy might be prey to his creditors ... defenses against "preference claims."

ments later and later after they are due. If a creditor is paid only after filing suit or as a result of applying other legal pressure, the payment usually will be ruled to be not in the ordinary course. You have little control over the facts on which this defense is based.

Another defense is that the debtor received new value for the payment now claimed to be a voidable preference. The reported case opinions are not in agreement about the application of this defense to construction industry cases. To come within construction cases which apply this defense, the materialman should be careful to send any required preliminary lien notices and 90-day notices of claims on payment bonds on the job. The materialman should take all steps necessary to protect lien and bond rights and, if still not paid, record his lien before the end of the period allowed by the statutes.

Courts allowing this defense reason that where the creditor has done all he can to protect his rights against a third party (owner or general contractor) and gives up those rights against the third party for payment by the debtor, a third party gives "new value" to the debtor by nakilg ths next progress payment to the debtor. If the materialman gaye a lien or bond waiver when receiving the money later claimed to be a preferential payment, the analysis should be more readily accepted by the bankruptcy court.

A final defense is that the claimed preferential payment was not made by the debtor. If the payment instead came directly from a payment bond surety, or from the owner or tbe general contractor's check payable jointly to the debtor and the materialman, the bankruptcy court may be willing to apply this defense.

If you have received a substantial payment from one who filed a bankruptcy petition less than 90 days laler, and if you suspect that the trustee may be entitled to rccover the money you received as preferential, you have a problem. The bankruprcy trustee has two years to begin legal proceedings against you to recover the payment. If it does so after the time has passed for you to sue on a payment bond or for foreclosure ofyour lien, you have the risk of losing on tbe tnrstee's preference claim and being baned from your remedies to recover from third parties if the payment was not made.

You might 6o lethin!, hoping that the trustee does not make a preference claim against you and that the problem will go away. But therc is a better answer when you have lien or bond righs. Your attorney could file a motion in the banknrptcy court asking that the court shorten the tine for the trustee to file a preference claim against you to a date before your time expires to file suit on your claim on the bond or lien. If the motion is granted and the preference claim is made, you will have time to process your lien or bond claim.

-Thc autlor is ot attortuey at lant with Strong and Pugh P.e., PlrenL Az, lrandling mainly conunercial litigation, with an emphasis on the constntction industry.