Take the Cash or the Claim? Intersection of Sections 502(h), 503(b)(9) and 547 of the Bankruptcy Code

In this episode, we delve deep into the realm of bankruptcy law and the issues faced by suppliers when shipping goods to financially distressed customers. 

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About the author
Edward L. Schnitzer

Transcript

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In a hypothetical situation, let’s say you ship goods to a customer that is having financial difficulties. The customer sends you a check for the goods. What do you do?

Do you cash it and potentially be sued for a preference after the customer files for bankruptcy? Or, do you skip cashing it and then have a claim in the ensuing bankruptcy?

The answer: cash the check. Reason being that if you receive a preferential demand later, you’ll usually have to return only a portion of the money and you’ll keep the rest. The alternative is worse because if you don’t cash it, you’ll have a general unsecured claim that is likely worth only pennies in the bankruptcy. 

Now, let’s change the hypothetical slightly. This time, it’s within 20 days of a bankruptcy filing, and you ship goods to a customer. As in the previous example, the customer sends you a check for the goods. What do you do this time?

Here, the answer is not so clear. 

If you don’t cash the check, you’ll have a Section 503(b)(9) administrative expense claim in the bankruptcy. That claim is far more valuable than a general unsecured claim because administrative expense claims are of a higher priority and must be paid in full for a plan to be confirmed.

But what happens in this situation if you cash the check? Well, you get the money now, and you’re possibly subject to a preference claim in the future. Then, if you have to return the money, even just 50% of it, that means you’re 50% out. Certainly not as good an option as having been paid in full on the administrative expense claim. 

Can you defend the preference by saying: “Well, I wasn’t preferred, since if I wasn’t paid this money, I would have had an administrative expense claim and thus would have been paid in full. In other words, the payment did not enable me to be paid more. And if I have to return the money, I’ll just file a 503(b)(9) claim at that time, which has to be paid in full, so this is all just a waste of time.“ 

But, will a court accept that defense? On January 18th, Bankruptcy Judge Lisa Beckerman of the Southern District of New York answered that question with a resounding NO.

In The Great Atlantic & Pacific Tea Company bankruptcy, the Official Committee of Unsecured Creditors filed a preference action against McKesson Corporation seeking the avoidance and recovery of roughly 67.7 million dollars. While that action has been pending for over 6 years and has a long procedural history involving numerous motions and decisions as well as two bankruptcy judges, the most recent decision came out on January 18th from Judge Beckerman. In this decision, Judge Beckerman addressed the following:

The Defendant argues … that any judgment rendered on the preference claim would be futile because the resulting section 502(h) claim for any avoided preferential transfers would not be an unsecured claim, but would be an administrative claim under section 503(b)(9) [as] … section 502(h) requires that the transferee be put back in the same position as it would be had the preferential transfer never been made. 

The Court denied the Defendant’s motion and held:

[I]f a preference judgment against the Defendant were rendered in this Adversary Proceeding, the Defendant paid the amount of the preference judgment in full, and then the Defendant filed a claim for the amount of the paid preference judgment, the Defendant would not have an allowed section 503(b)(9) claim, but would have an allowed unsecured claim in the amount of the paid preference judgment.

Judge Beckerman held that McKesson was seeking a 503(b)(9) post-petition claim, something that section 502(h) did not provide for as section 502(h) only provided for a pre-petition claim. 

In conclusion, the singer Steve Miller would tell you to take the money and run. Clearly, he didn’t moonlight as a bankruptcy attorney. Based on the holding in A&P v. McKesson, it is not clear if that is the best advice if a creditor would otherwise have a valuable 503(b)(9) claim.

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