Because of the Bankruptcy Trustee’s “strong-arm” powers, the news that the Revel Casino in Atlantic City has filed for bankruptcy should concern any contractor who received a payment from the owner of Revel — and they are many — within the last ninety days.   Under 11 U.S.C. Section 544, the Trustee is granted the ability to, among other things, seek the return of any payment made by the bankrupt party within ninety days prior to bankruptcy filing.

The Trustee’s strong arm powers come as a shock to many when they receive a letter demanding repayment of a payment made by the debtor, especially because the payment was probably long overdue and less than the full amount owed.   However, before you rush to write a check to the Trustee consider whether the following defenses to the Trustee’s preference action are available.

1.  New Value.

The Bankruptcy Code recognizes an exception to the Trustee’s strong arm avoidance powers when payment from a debtor is made in exchange for “new value.”  This defense is grounded in the principle that the transfer of new value to the debtor will offset the payment, and the debtor’s estate will not be depleted to the detriment of other creditors.

Material suppliers are the most obvious candidates for this defense because a supplier owed money for material previously supplied will usually refuse to supply additional material unless the previous material is paid for.  Likewise, a contractor who refuses to perform any additional work and to return to a project until past due invoices are paid could avail themselves of the new value defense as well.  

Some have argued that giving waiving or releasing lien rights in exchange for payment triggers a new value defense.  The theory is that the filing of a construction lien would diminish the bankruptcy estate in some capacity.  Case law is divided on the issue of whether a release of construction lien rights constitutes new value and the Third Circuit (whose jurisdiction covers the Revel Bankruptcy) has not addressed the issue.

 2.  Ordinary Course of Business.

The Bankruptcy Code also recognizes an exception to for “payment of a debt incurred by the debtor in the ordinary course of business or financial affairs of the debtor and the transferee; made the in ordinary course of business or financial affairs of the debtor and the transferee; and made according to ordinary business terms.”

Typically, this would mean that if your payment application was due within thirty days and payment was made within thirty days, then the Trustee could not avoid the transfer.  Of course, that is usually not the case in a construction related bankruptcy because if payment were made within thirty days their probably would not be bankruptcy.

Yet, even if payment is made beyond the time for payment set forth in the contract, the “ordinary course of business” defense may, nonetheless, be made available.  The theory that payments made beyond a contractual payment deadline are made in the ordinary course of business is predicated on the — unfortunate – fact that contractors often receive late payment.  Moreover, an ordinary course of business defense is strengthened if a contractor can show a pattern and practice of late occurring payments on a project.  This is because a contractor can argue that the terms of the parties agreement changed and their was an agreement to accept later payments and the alleged preferential payment was made according to those terms.

While these defense are far from foolproof and are not always successful, they nonetheless give a contractor negotiating leverage with the Trustee when a demand for repayment of a transfer is first received.

 

 

 

 

 

 

Stick around long enough and dealing with a bankruptcy during or after a construction project is inevitable.  Moreover, when a member of the construction “chain” – owner, contractor, or subcontractor – files for bankruptcy everyone is effected.

Receiving a Trustee’s “preference letters” might be largest cause of irate phone calls from clients to their attorneys.  Subcontractors and suppliers, in particular, are flabbergasted when they are told that the Bankruptcy Code permits a Trustee to require repayment of money even if the payment was due when the  debtor made it.  The Trustee’s “strong arm” power is a fitting moniker for Trustee’s ability to recover money rightfully owed when payment was made within 90 days of the date debtor filed bankruptcy.

In this month’s Construction Executive Magazine,  Michael R. King of Gammage & Burnham in Phoenix, gives a refresher  on what a contractor’s options are in responding to or defending against a Trustee’s demand for repayment of a “preferential” transfer.  The article also reminds us that further efforts to perfect, but not to collect or enforce, a mechanics lien are not subject to the Bankruptcy Code’s automatic stay provisions.  I recommend saving the article to your favorites as a quick reference guide for when you next receive a preference letter.

What the article does not discuss is an unpaid subcontractor’s super priority in unpaid funds either withheld from a debtor or retained by the debtor.  I have long been an advocate of subcontractors aggressively pursuing payment using this super priority. I am surprised how few subcontractors and suppliers pursue this claim.

Next time you have a payment owed form a debtor that files for bankruptcy, don’t simply write it off.  Instead, take a minute to explore your options.  What you will find is that you are not as bad off as you think.