When Payments Come Undone: Preferential and Voidable Bankruptcy Transfers

In this shaky economy, businesses that extend credit to customers are taking a big chance. If that customer files for bankruptcy, the business could find payments the customer recently made to the business confiscated by the bankruptcy trustee and returned to the bankruptcy filer's account.

How is that possible? Welcome to the world of preferential and voidable bankruptcy transfers.

When a company or individual files for bankruptcy, a trustee is appointed to oversee the bankruptcy. That trustee examines what the bankrupt party did with their assets and their cash in the three months before filing for bankruptcy. If the trustee sees payments or transfers of other assets which they view as an attempt to deprive the bankruptcy's creditors of what they're owed, they can use their "avoidance" powers to cancel the transfer.

You may ask -- isn't this business a creditor of the bankruptcy? It is, but the trustee wants to see all the creditors in a bankruptcy treated the same. So one business getting a big payment just before the filing spells unequal treatment for the other creditors. So a trustee might move to cancel a transaction.

Because there is a legal cost to voiding a transfer, this procedure is most often done in commercial bankruptcies, where the dollar amounts involved tend to be larger. Voiding transfers is rarely done in a Chapter 13 bankruptcy proceeding. Since the debtor is planning to pay off their debts over time, it's less important to call back payments to satisfy creditors.

The best way to avoid getting caught empty-handed with a cancelled payment or transfer is to not extend credit to customers. But in this economy, extending credit is often the only way to keep the business going, as customers are short of cash. Other good defenses include setting up a payment plan with customers, so you can show the payment was not unusual but part of a regular payment schedule.

There are several criteria trustees use to evaluate whether a transaction made in the 90 days prior to a bankruptcy filing should be voided, including whether the creditor was insolvent at the time, and whether the transfer allowed that creditor to receive more than they likely would have through the bankruptcy process. The trustee is looking for last-minute attempts to get rid of assets and keep them from creditors. Also highly suspect and subject to cancellation are any transfers of property or payments made to relatives or business partners.

If your business has had a customer payment canceled due to a bankruptcy or you're concerned this could happen, know that you can fight this seizure of your payment. To learn more about your rights concerning preferential or voidable bankruptcy transfers, contact the Michigan bankruptcy law office of Johnson & McLoyd.