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Bankruptcy Clawback: A Hole in Your Pocket

Posted on May 7, 2018 in

Stock photograph of a person's hand holding an ink pen over a calculator and sheet of paper with bar graphs on it.

You’re the head of a successful business (or a lawyer representing one). Profit margins are up, plans to expand into new markets are in the works, and the furthest thing from your mind is the Federal Bankruptcy Code.

But what many successful business people don’t realize is that it’s not just the status of their own finances that can draw the Bankruptcy Code into sight. In many cases, it’s the financial condition of the business’s customers, clients, and vendors. When one of these entities files for bankruptcy, the focus can shift to your thriving business as the recipient of payments from the debtor.  The Bankruptcy Code grants a trustee with broad powers to “claw back” certain payments for the benefit of the bankruptcy estate.

When an unsuspecting business like yours finds itself in the crosshairs of a bankruptcy trustee, mistakes and misconceptions abound. Here are three things to keep in mind:

  • First – don’t get heated. Your first reaction may be: “but I didn’t do anything wrong.” That is likely true, but it doesn’t matter. The trustee’s claw-back powers do not generally require any amount of knowledge or wrongdoing on the part of the target. Remember that one of the goals of the Bankruptcy Code is to level the playing field for all creditors. By paying your company before declaring bankruptcy, the debtor depleted funds that would otherwise be available to be divided among all creditors, pro rata. The trustee has a fiduciary duty to creditors, including your business, to see that each gets its fair share of the pie—nothing more and nothing less. This isn’t about emotion; it’s about economics and fairness.
  • Second – don’t bury your head in the sand. Procedures are slightly relaxed in bankruptcy court litigation. For example, litigation against your company will likely not start with the usual “you’ve been served.” In bankruptcy cases, service of a complaint is permitted by US Mail. But the consequences of ignoring that envelope can be severe. A judgment from a bankruptcy court is just as dangerous to your business as a judgment from any other court. It’s far better to seek advice of qualified bankruptcy counsel early than to wait until the trustee begins collection proceedings against your business.
  • Third – you probably have good defenses. Due to the harshness of the trustee’s claw-back powers, the Bankruptcy Code itself provides a number of defenses to businesses like yours. For example, a trustee generally cannot recover payments made in the same manner they’ve always been made pursuant to a long-standing contract with the debtor.

Bankruptcy law can affect the prosperous and downtrodden, alike. It is also a complex area of law that is unfamiliar to many business litigation attorneys. Knowing your rights and obligations when you find yourself in a bankruptcy trustee’s claws is key. An experienced bankruptcy practitioner can make sure that you do.