Potential Pitfalls in Subsequent Bankruptcies of Reliance on Joint Check Agreements
By Al Lurey
Under title 11 of the United States Code (the “Bankruptcy Code”), generally speaking, payments by
insolvent debtors to an unsecured or undersecured creditor on pre-existing indebtedness (so-called
“antecedent debt”) made during the 90-day period before the debtor’s bankruptcy filing (the
“Preference Period”) are vulnerable to claw-back in the debtor’s bankruptcy case as voidable
preferences. This is the case if the payments allowed the creditor to receive more than it would receive
in a chapter 7 liquidation of the debtor, if the payments had not been made and the creditor received
payment on its debt in the chapter 7 liquidation to the extent provided by the Bankruptcy Code. For
example, if an unsecured creditor owed $100,000 receives a $50,000 payment from an insolvent debtor
50 days before the debtor goes into bankruptcy and the projected recovery in a chapter 7 liquidation of
the debtor for creditors of its class is five cents on the dollar, the creditor’s position will have been
improved substantially by receipt of the $50,000 payment, if that payment is not required to be
disgorged as a voidable transfer.
If the $50,000 payment stands, the creditor would recover a total of $52,500 on its $100,000 claim ,
consisting of the $50,000 paid before bankruptcy and a 5% distribution in the chapter 7 liquidation on
the $50,000 balance remaining on its claim. If the pre-bankruptcy payment had not been made, the
creditor would receive only 5% of its $100,000 claim, namely, $5,000. Under such circumstances, unless
one of the recognized defenses to a preference claim is applicable, the $50,000 payment made during
the Preference Period can be recovered from the creditor by the representative of the debtor’s
bankruptcy estate. Even if the debtor filed a chapter 11 case and is continuing in business as a going
concern, the test is applied as if the case were a chapter 7 liquidation case.
The upshot of the foregoing is that, in order to promote (among other things) the bankruptcy policy of
equality of distribution among similarly situated creditors, a payment made during the Preference
Period on a perfectly legitimate debt may be recoverable from the creditor in the debtor’s bankruptcy
case.
A recent decision by the United States District Court for the Eastern District of Virginia, arising out of the
Truland bankruptcy cases, involved a $2.1 million preference claim brought by a chapter 7 trustee in
bankruptcy for a defunct subcontractor against a supplier that had provided electrical equipment (the
“Equipment”) to the subcontractor in connection with a large construction project. See Myers
Controlled Power, LLC v. Gold (In re Truland Grp., Inc.), No. 1:18-cv-979 (LMB/IDD), 2019 WL 2251704
(E.D. Va. May 24, 2019). In particular, the bankruptcy trustee alleged that, during the 90-day period
preceding the subcontractor’s bankruptcy filing, the supplier received, by means of a check from the
general contractor on the project made jointly payable to the subcontractor and the supplier, $2.1
million in payment of antecedent debt owed to the supplier by the subcontractor. The trustee
contended that, notwithstanding the joint check procedure employed to effectuate payment to the
supplier, the transaction constituted a transfer to the supplier of property of the insolvent
subcontractor during the Preference Period. He further alleged that this transfer enabled the supplier to
recover more than it would have recovered in the subcontractor’s chapter 7 case, if (i) the transfer had
