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Proactive Business Practices: Preventing Paying Preference Claims


Preventing and defending against preference claim payments have become important economic realities when doing business today. Preference payments are payments made by companies in the 90 days prior to filing bankruptcy that appear to be preferential to a creditor to the detriment of the bankruptcy estate. Whether the payments were made for the purpose of treating the creditor preferentially is not relevant; all payments within 90 days of filing are deemed to be preferences unless they meet one of four defenses provided under the bankruptcy code:

  • Payments made in the ordinary course of business (there’s a technical definition to this)
  • Cash in advance or cash on delivery (if certain conditions are met)
  • There is a new value of services provided after the payment that offsets the payment
  • The payment is for a money purchase transaction where a lien is filed against the items purchased

Having to disgorge a preference payment is very painful. Oftentimes, the payment recipient that has to disgorge a preference payment is also an unsecured trade creditor to the bankrupt company. As a result of the bankruptcy, the creditor receives little or no recovery from itsbankruptcy claim. Furthermore, unless there’s a successful Chapter 11 reorganization, the company has also lost a customer. Having to disgorge payments received, on top of writing off bad debt and losing the failed customer, adds insult to injury.

Preference claims can be successfully defended in some circumstances. Certain practices can be followed to set up these defenses and reduce the chance of having to disgorge preference payments. 

Things to keep in mind


Preference claims apply to payments received within 90 days prior to a bankruptcy filing. The number of days to collect is from the invoice date to the date the funds clear. The check date is not relevant to the ordinary course calculation.

In addition, most preference claims are negotiated, not litigated. The smaller the amount of the claim and the stronger the defense, the less likely the claimant is to pursue the claim. 

What do you do if you know a customer is distressed and you want to collect existing accounts receivable?


The ideal situation is to get paid approximately 28 days after invoice. Thirty days is the de facto standard for the “ordinary course” clause of the bankruptcy code. If you’re paid in approximately 30 days, you can likely prevail against a preference claim by simply stating that the payment was received in the ordinary course of business. Remember, the calculation is from invoice date to the date the check clears — not the date of the check.

The next best alternative is to get paid in the ordinary course if the past payment history is different from 30 days. This can occur if you have documented payment terms (e.g., 60 days), have a consistent track record of payments according to these terms within a few days (e.g., check clearing in 60 to 65 days), and receive additional payments within the same window of number of days from invoice.

If you’re unable to arrange any of the above, collect the money as early as possible in the hope of getting paid more than 90 days prior to a bankruptcy filing. While hope is not a plan, there may not be a preference claim at all depending upon the timing of filing and whether the parties end up pursuing a preference action. Also, even if the payment turns out to be subject to a preference claim, there will be a negotiated settlement, so you may be able to pay back less than 100 percent of whatever was collected.

Bottom line: it’s better to collect the cash prior to a bankruptcy filing at the risk of having to repay it then not collect it and hope that the bankruptcy proceeding results in a payment to unsecured creditors.

What do you do if you know a customer is distressed but wants to continue your relationship?


The best “go-forward” payment terms with a distressed customer are cash in advance (CIA) or cash on delivery (COD). These terms both assure payment and offer a strong deference against a preference claim. To assure that the COD defense will prevail against a possible future preference claim, the intent should be documented and payment must be received at the time the work product is completed. The ideal situation would be 1) a purchase order where the customer agrees that payment will be made at the time work is delivered, and 2) payment is received contemporaneous with delivery of the product or services.

The next best alternative to CIA or COD is to get paid in the ordinary course:

  • Document in the purchase order that payment terms are 30 days.
  • Receive payment approximately 28 days after invoice and deposit it promptly.
  • If you get paid in approximately 30 days, you can likely prevail against a preference claim by simply stating that the payment was received in the ordinary course.
  • Remember that the ordinary course calculation is from invoice date to the date the check clears.
  • Of course, when extending any open terms, there’s always the risk of doing the work and then not getting paid prior to filing.

If you can’t arrange payment per the above terms, the risk of having to disgorge a preference claim is high. If you’re providing goods or services to the customer on an ongoing basis, the preference risk can be reduced somewhat by collecting quickly and frequently. Under the new value defense, the value of what’s provided after receipt of payment can be offset against preference claims for those prior payments. Getting paid frequently (weekly, for example) means next week’s services would defend the prior week’s collection against a preference claim. Of course, any receivables unpaid at the time of filing are subject to all of the provisions of bankruptcy law and may well not be collected.

The last option is to collect money whenever possible from your customer and hope for the best. Big invoices on open terms close to a bankruptcy filing date that aren’t paid on COD terms, but paid in less than 30 days, will almost always result in preference claims. Catch-up payments on old invoices are typically hopeless to defend against a preference claim unless there’s new value provided after the payment that goes unpaid.

While you might not know if a customer’s bankruptcy is near, these are measures that you can take to protect yourself when doing business with a distressed customer. For more information, give us a call.

Contact Us

David Priestley

877.622.2257, x33405

Jamey Schalter

877.622.2257, x33748