How Collecting Money Owed Could Get Your Business in Trouble

For many businesses to survive, they need to make sure they’re paid by those that owe them money, whether from individual consumers, or other businesses. You may not think that simply accepting payment for a good or service rendered could embroil your business into a complex federal bankruptcy case. But it can happen.

The Clawback Suit

The problem for businesses stems from what are known as clawback suits.

Debtors in bankruptcy cannot pay creditors immediately before filing bankruptcy. The logic is that one creditor should not be favored over others. Thus, when a debtor, for example, pays his doctor the $200 he owes for a medical bill, then files bankruptcy, the debtor has “cheated” his other creditors out of that $200. This is called a “preferential transfer.”

Debtors usually will do this in good faith. Perhaps they are trying to “make things right” with certain creditors. A debtor may see your business as a friend, or a company that provided a real service, but see American Express as just a big bank corporate giant. Thus, the debtor may pay your business money owed before filing for bankruptcy.

Sometimes, a debtor will try to sell property of value before filing for bankruptcy. You may be the purchaser of these items. You may be excited to be able to purchase kitchen equipment, heavy machinery, or other expensive items, all for pennies on the dollar. But what’s really happening is that the debtor is liquidating its assets in anticipation of filing for bankruptcy, thus depriving its creditors of obtaining those assets.

When either of these scenarios happens, the bankruptcy trustee has a right to get back the money the debtor paid to you before the filing. That is done through a clawback suit. Even if you accepted the payment innocently and without knowing about the potential bankruptcy, you (or your business) can be a defendant in a clawback lawsuit.

Clawback suits gained a lot of publicity during the Bernie Madoff debacle. There, many innocent companies, including non-profits, received what they believed were donations or financial support from the Madoffs. When the bankruptcy trustee took over, he sought to make these companies cough up what they had received, so the original defrauded investors could get their money back.

Clawback Defenses

There are some defenses to clawback suits, including not having knowledge of the bankruptcy (although that’s not an absolute defense). In many cases, businesses will be able to retain their initial proceeds received from preferential transfers, but not any profits derived from those proceeds.

Additionally, regular payments that occur in the ordinary course of business may not be subject to a clawback suit. If a debtor pays your company your normal recurring invoice, that may be okay. If the debtor suddenly pays the last 6 months of delinquent invoices, that may be a problem. And, in Florida, as of 2013, nonprofit organizations have greater protections against clawback suits.

An experienced business law attorney can help your business avoid problems you may not even be aware could occur. Contact Tampa business attorney David Toback to discuss your needs and review documents your business relies upon to survive.