Jennifer S. Tamkin

While bankruptcy filings dropped during the Pandemic due to government aid and other factors, they have since been on the rise. According to U.S. Bankruptcy Court Statistics, 2024 saw a 14.2 percent increase in both individual and business filings from 2023. The rates of filings continue to rise as of Q1 of 2025.

Upon a bankruptcy filing, creditors face the obvious risk of unpaid invoices, but they may also soon find themselves the target of a demand or action for the return of payments received prior to the bankruptcy case being filed. These pre-bankruptcy payments are called preferential transfers and, under the Bankruptcy Code, can be clawed back for the benefit of the bankruptcy estate.

Christopher M. Candon

Under Section 547(b) of the Bankruptcy Code, debtors and trustees are granted the ability to recover preferential transfers made to creditors that were:

To or for the benefit of a creditor;
For or on account of an antecedent debt;
Made while the debtor was insolvent;
Made on or within 90 days immediately preceding the bankruptcy petition date (or within one year if to an insider); and
That enabled the creditor to receive a greater percentage of its claim than it would otherwise receive in a liquidation under Chapter 7 of the Bankruptcy Code.

11 U.S.C. § 547(b). Under Section 547, the debtor or trustee can “reach back” and pull any transfers made up to ninety days (1 year for insiders) before the petition date back into the bankruptcy estate. This preference avoidance power is intended to maximize the funds available to pay creditors and further the Bankruptcy Code’s policy of equitable distribution of the debtor’s estate among similarly situated creditors. But for those that are the targets of a preference action, the lawsuits are difficult to comprehend and frequently just exacerbate the burden already imposed by the bankruptcy filing of a vendor or business partner. Fortunately, the Bankruptcy Code does provide certain defenses to defend against preference actions. These defenses further the policy of not punishing parties from doing business with financially distressed customers.

Section 547(c) of the Code provides numerous defenses which will prevent a debtor or trustee from avoiding an otherwise preferential transfer. Once the five elements of Section 547(b) are proven, the debtor or trustee has established a prima facie case. The burden of proof then shifts to the defendant-creditor to provide a defense to the preferential transfer. Under Section 547(g), the transferee has the burden of providing the non-avoidability of a transfer, typically using the best-known defenses under 11 U.S.C. §§547(c)(1), (2), and (4):

Contemporaneous Exchange for New Value Defense, 547(c)(1)

A creditor can defeat a preference claim by showing that a transfer was intended by both the debtor and creditor to be a contemporaneous exchange for new value, and in fact substantially contemporaneous.

The best way to preserve this defense when doing business with a potentially distressed company in the commercial context would be to conduct cash on delivery (C.O.D.) transactions, or immediate payment for goods delivered.

Ordinary Course of Business, 547(c)(2)

A creditor can also defeat a preference claim by showing that a transfer was made in the ordinary course of business or financial affairs between the debtor and the creditor, or according to ordinary business terms within the industry.

Courts may examine a number of factors: payment history between the parties, timing of payments, method of payment, and whether there were any changes in collection behavior between the parties to determine whether the transaction was consistent with prior dealings between the parties or industry standards.

Subsequent New Value, 547(c)(4)

Lastly, of the popular defenses, a creditor can limit liability in a preference action by showing that after receiving a preferential payment, they provided goods, services, or other consideration of new value to the debtor that were not otherwise secured and remained unpaid as of the petition date.

The new value must be provided after the alleged preferential transfer(s). A 547(c)(4) defense encourages creditors to continue doing business with struggling businesses.

The best way to limit liability for a preferential action is to keep good records. They are often relied on in defending claims. If you, your company, or your client, is aware of a company in distress, consider moving to a C.O.D. or pre-payment method of business. If business transactions are consistent, try not to change the collection behavior, as such actions may expose a company to preference liability upon filing bankruptcy.

Once a bankruptcy case has been filed, parties should not ignore a demand for the return of an alleged receipt of a preferential transfer. By responding to the demand, a resolution is frequently achieved that avoids the filing of a formal adversary proceeding with the Bankruptcy Court. Once an adversary proceeding is commenced, the defendant/recipient of the preferential payment must prepare to negotiate a settlement and/or respond to the complaint. The more evidence of the above defenses the better.

Jennifer S. Tamkin is a member of Sheehan Phinney’s Business Litigation Group. Christopher M. Candon is co-chair of the firm’s Bankruptcy, Restructuring and Creditors’ Rights Group.