§ 365(b)( 1). In contrast, rejection of a
contract constitutes a material breach
and affords the creditor an unsecured
claim for damages as of the petition
date. Bankruptcy Code § 365(g)( 1).
Therefore, creditors whose contracts
are assumed or assigned recover more
on their prepetition claims than do
creditors whose contracts are rejected.
In addition to properly asserting their
claims against a bankruptcy estate, trade
creditors must also be mindful that the
estate might have claims to assert
against them. For instance, debtors
can seek to claw back payments that
were made to trade creditors in the
90 days before the bankruptcy case
was filed. In virtually any retail debtor
case, the estate will have preferential
transfer claims to assert under
Section 547 of the Bankruptcy Code.
Payments are preferential if a debtor
can satisfy a five-part test examining if
the payment ( 1) was made to or for the
benefit of a creditor; ( 2) was made on
account of an antecedent debt; ( 3) was
made while the debtor was insolvent;
( 4) was made within 90 days before
the bankruptcy case was filed; and
( 5) enabled the creditor to receive more
than it would in a Chapter 7 liquidation.
As noted earlier, if a trade creditor has
a letter of credit, then payment on its
invoices in the 90 days before bankruptcy
are not preferential. A payment by
the issuing bank to the creditor does
not constitute a transfer of property
of the bankruptcy estate. The bank’s
obligation to pay on the letter of credit
is deemed independent of the debtor’s
reimbursement obligation to the bank.
The fifth element of the test applies
when a trade creditor supplies goods
on an unsecured basis. Payment in full
for those goods likely would exceed
what an unsecured creditor would
receive in a Chapter 7 liquidation case.
Thus, this preferred creditor would
have received a greater amount in the
90 days before bankruptcy than it and
other trade creditors would receive
as distributions on their prepetition
claims in the bankruptcy case.
Even if a debtor can demonstrate all
five elements, the Bankruptcy Code
provides creditors with defenses to
preferential transfer claims. The most
common defenses asserted are the
ordinary course of business defense,
the contemporaneous new value
defense, and the subsequent new
value defense. These defenses prevent
or reduce clawbacks of transfers
because the creditors continued
doing business with the debtor
in the 90 days before bankruptcy
in a manner that the Bankruptcy
Code says should be respected.
The ordinary course of business
defense applies when a transfer was
payment for an obligation incurred by
the debtor in the ordinary course of its
business or financial affairs, made in the
ordinary course or financial affairs of
the debtor and the transferee, or made
according to ordinary business terms.
The creditor must show a consistent
history of invoices to and payments
by the debtor both during and before
the 90-day prepetition period.
The contemporaneous new value
defense applies when a debtor makes
a transfer to a creditor, and at or about
the same time, the creditor supplies the
debtor with new value. The subsequent
continued on page 24
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