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A New Regime in Preference Litigation
To a layperson, the idea that a debtor can assert a cause of action against a company who supplied goods or services to a debtor before the bankruptcy case, whom the debtor then paid, seems preposterous. Yet the Bankruptcy Code gives trustees and debtors in possession that right in 11 U.S.C. Section 547 — the right to seek to recover a payment to a third party in the 90-day period prior to the commencement of a bankruptcy case as a "preference."
Justifiable frustration at this provision, and mass preference litigation, has encouraged Congress to act. On Aug. 23, 2019, the Small Business Reorganization Act of 2019 (SBRA) became law, effective Feb. 22, 2020. One of the provisions of the SBRA amends the language of Section 547, to add a due diligence requirement. Though the intent behind the added language seems clear, it may not have its intended effect.
There are two conflicting dynamics in preference litigation, each of which is correct some of the time, and if correct, cancels the other out. The first is that goods suppliers and service suppliers do business with companies all the time, and in every transaction, there is the assumption of risk by the supplier that they will receive payment. Suppliers cannot always know when — or if — their customers are in financial distress. Thus, should one those customers commence a bankruptcy case, that is the cost of doing business. The supplier may have to wait years in order to obtain payment, if at all, on recently shipped goods.
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