By James J. Reynolds of Shustak Reynolds & Partners, P.C. posted on Wednesday, November 20, 2019.

Financial Network

Anyone who has been through it remains dumbfounded. Those about to experience it are sure to become flabbergasted. I am talking about a bankruptcy trustee’s ability to claw-back your hard-earned money because you were paid by the “wrong payor.”

Some of you may be aware of  a bankruptcy “preference claim” which occurs when one of your customers files for bankruptcy and the bankruptcy trustee seeks to force you to give back any payments from your customer during the 90 days preceding the bankruptcy, i.e. the Preferential Transfer ( 11 USC 547). The principal underlying “preference claims” is that all creditors should be treated equally and payments to any particular creditor made within 90 days of the bankruptcy is considered unfair, unless a valid defense is available, to the other creditors who may not have received any payment. This concern over financial abuse goes back to England’s Elizabethan era and the unscrupulous insolvent person giving away their money to friends or relatives rather than true creditors.

Once the 90 Day Period runs without any payment from your customer, you can relax since you can’t be sued on a preference. Not so fast. Two years later you face a complaint from the bankruptcy trustee, for the same bankrupt customer, demanding that you return ALL payments from the customer made to you over the TWO YEARS preceding the bankruptcy. It’s one of your better customers and a good deal of money is involved.

The basis for this claim is colloquially known as the “Wrong Payor.” (11 USC 548–Fraudulent Transfers and Obligations). In plain English, you send an invoice to a customer and you are paid by someone other than the customer. The bankruptcy trustee can then force you to return all payments because the wrong payor paid your bill, which can happen for several reasons. For example, a large national or multinational company may be comprised of dozens of different companies which, when faced with a financial crisis, creates what is known as a “cash management account” which is used to pay all the creditors of the different corporations, including you. If you had looked closely at the payment to you, made via wire transfer, check or other payment form, you would have noticed the payor’s name wasn’t the name of your customer. Rather it was the entity in charge of the cash management account.

Few of us experience anything other than gratification when paid for our work, services or products. Fewer still examine the payment to ensure the name of your customer is on the payment. After all, you got paid, what difference does it make who paid you?

It makes a difference to the bankruptcy trustee and lawyers working on behalf of the trustee. They can and do sue every creditor paid over the prior two years through the cash management account since the account holder will not be the entity (your customer) that received the benefit of your services of goods. The basis for the Wrongful Payor claw-back is that the bankruptcy estate did not receive “reasonably equivalent value” since your services or products were provided to your customer and not the entity that paid you. Flabbergasted, angry, shocked? You should be.

To avoid exposure to a Wrongful Payor claim be certain your customer’s name is on the payment. This becomes especially important should you become aware of a customer experiencing financial distress. The odds of bankruptcy are increased along with the possibility of either a Preference or Wrongful Payor claim.

Should you receive notice of such a claim, which typically is made via a demand for payment by the trustee, don’t ignore it. The claim won’t go away and failing to deal with it will increase your exposure. Contact an attorney to determine how best to handle the situation.

Shustak Reynolds & Partners, P.C. focuses its practice on securities and financial services law and complex business disputes. 
We represent many broker-dealers, registered representatives, investment advisors, investors and businesses. 
Partner James J. Reynolds can be reached in the firm’s San Diego office at (619) 696-9500. 

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