Law Offices of Nicholas Gebelt

Should We Pay Any Creditors Back, Especially Those We May Want To Have A Business Relationship With In The Future?

  1. Preferences
  2. A problem arises if a business starts paying creditors on the eve of bankruptcy. The problem is a concept called “preference,” sometimes referred to as preferential transfer. To understand what’s going on, it helps to keep in mind the two main goals in bankruptcy.

    The first goal is to give the debtor debt relief, whether it’s an individual debtor or, in this case, since we’re discussing businesses, a business debtor reorganizing and getting back on track.

    The second goal in bankruptcy is to ensure that similarly situated creditors are treated equally and fairly. There are two ways that debtors will sometimes violate it:

    First, they won’t list all the creditors in the bankruptcy papers. The person who signs the bankruptcy papers will sign them under penalty of perjury, and if there are creditors who have not been listed, that person may face criminal liability associated with perjury.

    Second, they may make preferential payments to a given creditor in anticipation of bankruptcy. When a debtor does that, it’s treating that creditor more favorably than other similarly situated creditors — i. e. , it’s preferring that creditor above other creditors; hence the term “preference. ” In the bankruptcy case the preference must be undone.

    Let’s say the business filed a Chapter 11, so it’s reorganizing. When the bankruptcy papers are filed, the act of filing them creates a bankruptcy estate that contains everything that the business owns or has an interest in. The business or the business owner must act as a fiduciary for that bankruptcy estate and maximize its benefit for the creditors. As a result, the business is obligated to file a preference avoidance action to undo that preference and take the money back. What is the lookback period? If the payment was to an ordinary creditor, then measured from the day the petition is filed, the debtor must avoid any preferences done during the 90-day prepetition period. If it’s an insider creditor, then the lookback period is one year. (A little vocabulary: The petition date is the day of the filing of the petition; prepetition is before that date; post-petition is after that date.)

    Therefore, it is best not to pay creditors unless you wait a long enough time to pass the lookback period.

  3. Critical Vendors
  4. Some clients may worry that they will not be able to work with the creditor again. That’s when we might give the creditor a call before filing and explain this idea of preference.

    Once we file the bankruptcy, we’ll prosecute a critical vendor motion, to get permission to pay vendors that are critical to the success of the business. If the judge grants permission to continue paying, then that creditor can be paid on an ongoing basis. However, prepetition claims must be paid through the plan, once the Court confirms it

    As a general principle, don’t start paying creditors on the eve of bankruptcy. If you do, either wait a long enough time, or make the dollar amounts small enough that they’re below the cut-off for requiring avoidance actions. Also, reassure the creditor, if it is a critical vendor creditor, that after filing the papers, you’re going to immediately ask the judge for permission to continue paying that creditor on an ongoing basis so that the business can succeed.

For more information on SBRA & Business Bankruptcy In California, a free initial consultation is your next best step. Get the information and legal answers you are seeking by calling (562) 777-9159 today.

Attorney Nicholas Gebelt

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