Prudent Collection Action May Be Hazardous to Your Preference Defense

If there is one pill tougher for a creditor to swallow than being owed significant indebtedness by a financially distressed customer that has filed a bankruptcy case, it is collecting outstanding invoices from its customer only to later find out those payments are subject to turnover as a preference after its customer’s bankruptcy filing. Preference claims continue to plague trade creditors who received payments from a customer within 90 days of the customer’s bankruptcy filing because the Bankruptcy Code provides that these payments are subject to disgorgement.

Creditors can reduce their exposure by asserting an array of preference defenses. However, the recent decision of the United States Court of Appeals for the Third Circuit (the “Third Circuit”), in Burtch v. Prudential Real Estate & Relocation Services, Inc., et al. (“Prudential”), illustrates how a trade creditor’s prudent collection efforts ultimately precluded the creditor from proving one of these preference defenses, the ordinary course of business defense, that would have mitigated its preference liability.