Beware of the “Clawback” Claim, but Also be Aware that it is as Much an Accounting Issue as a Legal One

Finance | Corey H. Neubauer | Oct 15, 2019

There will be a time when your client’s customers will go through a rough patch and have the need to file for bankruptcy protection. Before filing, one of these customers may, out of loyalty or with an eye to the future, pay this client.

But if your client receives this sum less than 90 days prior to the debtor’s bankruptcy filing, this payment could be deemed a “preferential payment,” meaning your client may be required to return this sum for inclusion in a bankruptcy estate for equitable distribution among the debtor’s creditors.

This process, authorised by Section 547 of the US Bankruptcy Code, is commonly referred to as a “clawback.” And, while many consider clawbacks a legal issue, our accounting firm, Prager Metis, maintains an insolvency niche ready to assist with defending any clawback claims. This begins by understanding preferential payments, described above, and fraudulent conveyances.

Preferential Payments and Insiders

If your client’s customer is an individual debtor, his/her debtor’s considered insiders are relatives, close friends, etc. For a corporate debtor, insiders include directors, officers, partners, etc. Insiders cannot receive payment less than one year before filing. That said, there are defenses to a preference action. The most common are payments made to your client in the ordinary course of business and new value considerations.

Fraudulent Conveyance or Transfer

This typically occurs when a debtor transfers assets for less than fair value. Trustees can claw back these transfers made up to two years prior to the bankruptcy filing. (Some states, like New York, are six years.)

Finally, if your client can be legally paid by a customer, even one on the cusp of bankruptcy, the client should accept payment. Simply put, there is no guarantee your client will face a clawback down the road, and not only are defences available, exceptions can be argued, settlements made, and our firm can help implement them.