Trustee Clawback Explained
Receiving payment from a customer only to have a bankruptcy trustee sue to take it back months later is one of the more alarming surprises in trade credit. These lawsuits – called preference actions – are a routine part of bankruptcy administration. Understanding when you are exposed and what defenses are available can save you the cost of a lawsuit or settlement.
What is a preference payment in bankruptcy?
Under 11 U.S.C. § 547, a preferential transferis a payment made by an insolvent debtor to a creditor within a defined lookback period before the bankruptcy filing that allows that creditor to receive more than they would have received in a Chapter 7 liquidation. The bankruptcy trustee can sue to "avoid" (reverse) such a payment and return the funds to the estate for distribution to all creditors equally.
The logic: if a debtor paid you $50,000 two months before filing while being insolvent, and general unsecured creditors are receiving 5 cents on the dollar, you received preferential treatment. The trustee can recover the difference so all creditors are treated equally.
What is the 90-day preference window?
For payments to non-insider creditors (ordinary trade suppliers), the lookback period is 90 days before the petition date. Any payment you received during this window may be subject to a preference action if the debtor was insolvent at the time (which is presumed during the 90-day period) and if you received more than you would have in a Chapter 7 liquidation.
For insiders (officers, directors, relatives, or affiliates of the debtor), the lookback period extends to one year before filing.
How do you defend against a preference claim?
Several statutory defenses can reduce or eliminate your liability:
- Ordinary course of business defense (§ 547(c)(2)):The payment was made in the ordinary course of the debtor's and your businesses and was consistent with ordinary business terms in the industry. This is the most commonly used defense for trade creditors. To establish it, you typically show that your payment history with this customer follows a consistent pattern (similar timing, similar amounts) and that the 90-day payments weren't dramatically different from the prior 2–3 years.
- New value defense (§ 547(c)(4)): After receiving the allegedly preferential payment, you gave the debtor new value (shipped more goods or provided more services) on unsecured credit that remained unpaid at the time of filing. The new value offsets the preference dollar for dollar.
- Contemporaneous exchange defense (§ 547(c)(1)): The payment was intended as a contemporaneous exchange for new value (i.e., payment on delivery or COD), not payment of a prior debt.
- Small-amount exemption (§ 547(c)(9)): In cases where the debtor is not an individual, preference actions for amounts under $7,575 are exempt. (Note: this threshold is periodically adjusted.)
What records do you need to defend a preference claim?
The ordinary course of business defense requires evidence of your historical payment pattern with the debtor. Pull together:
- Invoice dates, due dates, and payment receipt dates for the 2–3 years before the filing
- Average days-to-pay for the pre-preference period vs. the 90-day preference period
- Any communications about payment delays or disputes
- Your industry's standard payment terms, if you can document them
- Records of any new value provided after each preference payment
What happens if you receive a preference lawsuit?
Preference lawsuits are typically filed as adversary proceedings in bankruptcy court, usually 1–2 years after the filing date (the statute of limitations is 2 years from filing). Many are settled before trial. If the preference amount is small (under $50,000), the trustee may send a demand letter first. Respond promptly: ignoring the demand or a complaint will result in a default judgment.
Retaining an attorney experienced in bankruptcy preference defense is usually worthwhile for claims above $25,000. Attorneys often negotiate settlements at 20–50 cents on the dollar of the claimed preference.
How does early warning reduce preference exposure?
The earlier you learn a customer is heading toward bankruptcy, the sooner you can shift to COD or prepayment terms. Payments received before the 90-day window are not subject to preference recovery. New value shipped after a preference payment also offsets your liability. Early detection lets you manage both levers.
Know before the 90-day window starts – not after it ends.
CaseWarn alerts you the morning after a filing is detected – typically 18 days before the official trustee creditor notice arrives.
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