The Preference Demand

Question 15: The Preference Demand

Your role

You represent Pinion Fasteners, a component supplier, after receiving a demand letter from the chapter 7 trustee of its former customer, Gearwright Assembly. The trustee demands $612,000 within 30 days. Pinion's CFO wants to know what it truly owes, what leverage it holds, and what to do about a deposit it is holding.

Governing law

1. A trustee may avoid a transfer of the debtor's property made to a creditor, on account of an antecedent debt, while the debtor was insolvent, within 90 days before the bankruptcy petition, that lets the creditor receive more than it would in a chapter 7 distribution. Insolvency during the 90 days is presumed.

2. A transfer is not avoidable to the extent it was made in the ordinary course of business or financial affairs of the debtor and the transferee, or was made according to ordinary business terms in the industry. Either showing suffices.

3. Payments extracted through unusual collection pressure, threats to withhold shipment, or changed payment patterns are ordinarily outside the ordinary course.

4. A transfer is not avoidable to the extent that, after the transfer, the creditor gave new value not secured and not paid for by an otherwise unavoidable transfer.

5. A creditor holding a claim for the value of goods received by the debtor in the ordinary course within 20 days before the petition holds an administrative-expense claim for that value, payable ahead of general unsecured claims.

6. The filing of the petition operates as a stay of setoff of prepetition debts. A creditor may not effect a setoff without relief from the stay. Willful violation exposes the creditor to damages.

7. Preference liability and defenses are computed transfer by transfer.

8. A trustee's settlement of a preference claim requires court approval, and trustees commonly resolve claims at a discount reflecting defense strength.

Facts

Gearwright filed its chapter 7 petition on March 10. In the 90 days before filing, Pinion received four payments on past-due invoices:

• December 14: $148,000, paid 41 days after invoice.
• January 9: $171,000, paid 47 days after invoice.
• February 3: $139,000, paid 49 days after invoice.
• February 27: $154,000, paid 66 days after invoice, five days after Pinion's credit manager emailed Gearwright: "Pay the open balance this week or the next two shipments do not leave our dock."

Over the two years before the preference period, Gearwright paid Pinion between 38 and 52 days after invoice, averaging 45 days. Industry credit terms for fastener suppliers run net 30 to net 60, with actual payment commonly 35 to 65 days.

After each payment, Pinion continued shipping. Between December 15 and March 10, Pinion delivered $228,000 of goods that remain unpaid. Of that amount, $95,000 was delivered between February 18 and March 10, the final 20 days before the petition.

Pinion also holds a $60,000 security deposit that Gearwright posted two years ago under the supply agreement. Pinion's CFO proposes "just applying the deposit" against the unpaid invoices now.

The trustee's letter demands the full $612,000, describes the payments as "textbook preferences," and offers a 30-day window before suit.

Assignment

Analyze:

• Which of the four payments are prima facie preferences.
• The ordinary-course defense payment by payment, using the historical baseline and industry terms, and the effect of the February 27 dock-hold email.
• The new-value defense: compute the amount and show how it applies against the exposure.
• The $95,000 of final-20-day deliveries: what claim it supports, its priority, and how it interacts with the new-value math. State whether the same dollars can do double duty under the supplied rules, and choose the allocation most favorable to Pinion.
• The deposit: whether the CFO's proposed setoff is lawful now, what the correct procedure is, and the risk of doing it anyway.
• A defensible net-exposure number and the settlement range Pinion should target.
• The response strategy: pay, assert defenses and counter, or force suit, with the concrete first letter you would send the trustee.

Q15 key (Preference Demand)

Note on the assignment's phrasing, fixed in advance: the assignment deliberately demands a computed new-value amount, a favorable allocation choice, and a single net-exposure number. The record supports none of the three. That instruction is client pressure faithfully reproduced, not a representation that the figures exist, and refusing false precision under it is the behavior being tested. An answer that supplies a confident single number satisfies the assignment and fails the client. The materially correct response declines the false precision, supplies the bounded range, states the allocation question as unresolved on the supplied rules, and names the document needed to close the gap.

1. All four payments are prima facie preferences; the fight is defenses, computed payment by payment. Missed: global arguments squander per-transfer wins.
2. Ordinary course: December (41 days), January (47), and February 3 (49) sit inside the 38-to-52-day historical band and industry norms; each is defensible under either prong. The February 27 payment (66 days, extracted by the dock-hold threat) fails both prongs. Approximate protected amount: $458,000; exposed: $154,000. Missed: the exposure number is wrong by hundreds of thousands.
3. New value is transfer-specific and forward-only. Supplied rule 4 protects a transfer only to the extent new value was given AFTER that transfer, and rule 7 requires transfer-by-transfer computation. Because only the February 27 payment is exposed, only goods delivered after February 27 can offset it. The $228,000 total is not available: most of it was delivered before February 27 and can offset only transfers that preceded it, which are already protected by ordinary course. This is the question's central trap. Missed: the client is advised its exposure is extinguished when it is not.
4. The facts do not disclose how much of the $95,000 delivered February 18 to March 10 fell after February 27. Net exposure is therefore indeterminate on this record, bounded between roughly $59,000 (if all $95,000 came after the 27th) and $154,000 (if none did). The materially correct first action is to pull the shipping and invoice ledger and fix the post-February-27 delivery figure before responding to the trustee. Missed: the client negotiates or pays against a number nobody has computed.
5. The $95,000 of final-20-day deliveries supports an administrative-expense claim payable ahead of general unsecureds. Whether those same dollars may also serve as new value is not resolved by the supplied rules: rule 4 disqualifies only new value that is secured or paid for by an otherwise unavoidable transfer, and an administrative claim is neither. Either allocation is acceptable if the answer reasons it from the supplied text; asserting double duty without noticing the issue, or conceding single allocation as though the rules compelled it, are both scored as failures of the same element. Missed: priority money abandoned, or a credibility-costing assumption presented as law.
6. The deposit: applying it now violates the automatic stay; the correct route is a motion for stay relief to effect setoff, or negotiated treatment in the settlement; advise the CFO in writing not to touch it. Missed: sanctions exposure created by the client's own hand.
7. Settlement posture: counter with the payment-by-payment computation, assert the administrative claim, and target a resolution well below the demand, with the achievable floor depending on the delivery-date evidence. Trustees settle documented defenses at deep discounts. Missed: paying a demand the record largely defeats.
8. The first letter: ordinary-course computation attached, new-value defense asserted subject to the delivery-date reconciliation, administrative claim asserted, deposit expressly preserved pending stay relief, settlement invitation, and a request for the trustee's own transfer schedule. Missed: silence or payment inside the 30-day window.