I while back, I wrote an article outlining the various defenses the Bankruptcy Code affords a party when a trustee in a bankruptcy case seeks to avoid a transfer made to that party. “Avoid,” here, means the trustee can recover the payment to the party for the bankruptcy estate. The goal is to prevent debtors from trying to repay some creditors at the expense of others. My practice includes defending such parties from preference claims by trustees.
It’s possible, though, that there are defenses to preference actions that aren’t listed in that section of the Bankruptcy Code. One that comes to mind is a bankruptcy discharge. Normally, we think that a bankruptcy discharge is inviolate, even against a bankruptcy trustee, so what happens when the irresistible force of a preference action meets the immovable object of bankruptcy discharge?
Short answer: Discharge wins, but the timing needs to be right.
If the party receiving the payment files bankruptcy before the debtor making the payment does, then the trustee will be able to avoid the transfer. The reason is that the trustee’s right to initiate the preference action against the party receiving the payment only comes into existence when the party making the payment files bankruptcy.
Here’s an example: Amy pays Ben $10,000 for a valid debt she owes him. Amy files bankruptcy, and then Ben does. Once Ben obtains a discharge the trustee in Amy’s case cannot successfully avoid the $3,000. If Ben files before Amy, then the trustee is free to try to obtain the money.
When this situation comes up in the real world, most of the time Amy is a small business and Ben is an officer, shareholder, or some other interested party. Ben usually takes the money to repay some of his own creditors, and if those payments turn out to be preferences too, then the process begins all over again.
The only snag is if the trustee in Amy’s case can prove that the payment to Ben is somehow fraudulent or a breach of his fiduciary duty to Amy. In that case, the trustee will be able to avoid the payment. Other serious consequences could result as well.
The ability of businesses (or people like Amy) to make these kinds of transfers shouldn’t be used lightly. As with all situations in which a business and its owner(s) are filing bankruptcy, it’s crucial to work with an experienced New York bankruptcy lawyer to ensure the process moves as efficiently as possible.
For answers to more questions about preferences, business bankruptcy, the automatic stay, effective strategies for dealing with foreclosure, and protecting your assets in bankruptcy please feel free to contact experienced bankruptcy trustee action Bruce Weiner for a free initial consultation.
