Watch Your Step

If your client goes bankrupt, you could be the one to lose.

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Entrepreneur magazine, March 1998

Bob Bernstein, business bankruptcy specialist and managing partner of Pittsburgh-based Bernstein Bernstein and Strickland PC, calls it a double whammy: A customer just filed for bankruptcy and you're looking at writing off a sizable debt--and now the bankruptcy trustee informs you that you must return the customer's last payment. What's going on?

In bankruptcy language, it's called a preference payment--and while there are many situations in life where being preferred is a good thing, bankruptcy is not one of them. It means a debtor is paying bills so that some creditors are receiving a greater percentage of what is owed them than other similar creditors are. For example, a debtor might make preference payments to suppliers with whom it has personal relationships, then file bankruptcy, leaving the remaining creditors scrambling for their money. Sure, it sounds good if you're the creditor getting the extra cash, but under the Bankruptcy Code, that's illegal. Bernstein says preference payments undermine the intent of bankruptcy laws to treat creditors of similar status as equally as possible.

So should you respond to the trustee's letter with a check? "Absolutely not," says Bernstein. Just because the trustee says you've received a preference payment doesn't mean you actually have or that you'll have to pay it back. Bernstein says the initial burden of proof that the payment was indeed a preference payment falls on the trustee. In legal terms, the trustee must be able to show that the payment 1) was to or for the benefit of you, the creditor; 2) was for old debt; 3) was made while the customer was insolvent; 4) was made on or within 90 days of the date of the bankruptcy petition; and 5) would allow you to receive more than you would have received had there been a liquidation under Chapter 7 of the Bankruptcy Code.

Even if the trustee can prove these points, you may have a legal defense that would allow you to keep the money, or you may be able to negotiate a settlement that would reduce the amount you must repay. Before taking any action, Bernstein recommends consulting with an attorney who works in the area of creditors' rights and bankruptcy and who can assess the situation and give you a realistic picture of your options.

Contact Sources

Bernstein Bernstein and Strickland PC, (412) 456-8101,

Jacquelyn Lynn is a business writer in Winter Park, Florida.

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