Nothing is more frustrating to a trade creditor saddled with a large unpaid balance owed by a debtor in bankruptcy than being subject to the risk of having to remit back to the debtor’s estate “preference” payments received from the debtor prior to the commencement of the bankruptcy case. Pursuant to section 547(b) of the Bankruptcy Code, a debtor in possession or trustee can seek the recovery of alleged preference payments made within 90 days of the bankruptcy filing date.

This is the harsh reality faced by the approximately 750 trade creditors (and counting) who have recently been sued in the Sears Chapter 11 case for the recovery of payments they had received within 90 days of Sears’ bankruptcy filing date. The policy behind the preference statute is to treat creditors equitably and level the playing field by requiring preferred creditors to share their recovery with all other creditors. Unfortunately, the reality is that preference recoveries are used to pay higher priority claims, such as the unpaid Chapter 11 administrative expense claims owing by Sears that must be paid as part of Sears’ Chapter 11 plan. And creditors defending preference lawsuits would more likely characterize the complaints for recovery of “preference” payments as punishment for continuing to do business with a financially distressed customer.

So, what should a creditor do when it first receives a preference demand letter and is then subsequently sued? What defenses can a creditor assert to rebut a preference claim? How should a creditor go about responding to, defending and/ or settling a preference claim? This article answers these questions by providing a step-by-step checklist of the actions a creditor should take starting from the date that a customer files for bankruptcy (the “Petition Date”) through the resolution of a preference litigation. A creditor is far better off spending the time compiling and presenting proof of its potential defenses to a preference demand than simply paying the amount demanded.

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