Bankruptcy Reform Act of 2005: What it Means to the Credit and Financial Professional, The

Credit & Financial Management Review, Second Quarter 2005 by Blakeley, Scott

The 2005 Act makes it easier for the vendor to prove up the ordinary course of business defense by allowing the vendor to establish either that the payment was ordinary between the debtor and the vendor, or that the payment was ordinary in comparison to the terms in the industry. The vendor is no longer required to prove both elements.

What it Means for Vendors

This provision strengthens the ordinary course of business defense. Provided the debt is incurred in the ordinary course of business, the vendor should prevail assuming that either the payment was in the ordinary course of business between the vendor and the debtor, or that the payment was made according to ordinary business terms.

Extended Period for Creditors to Perfect security Interest (section 403)

The 2005 Act provides a creditor up to 30 days to perfect their lien, thereby reducing the risk that a vendor's act of recording a security interest during the preference period may be challenged as a preference.

What it Means for Vendors

Vendors that take a security interest, consignment, or purchase money security interest in the goods they sell are subject to the preference laws, as such transactions are transfers under the preference laws. With the extended period to perfect a security interest, vendors are given greater protection from a preference challenge.

Rewriting the Fraudulent Conveyance Laws

What is a Fraudulent Conveyance? (section 548)

A debtor, whether individual, corporation, LLC or partnership, may devise a scheme to channel assets from creditors. Under state and federal law, these types of transfers are referred to as intentional fraudulent transfers. Under section 548 of the Bankruptcy Code, a trustee may attack a transfer made within a year of the bankruptcy filing.

Reach Back Period Extended (section 548)

The 2005 Act permits assets that are fraudulently transferred within two years of the bankruptcy filing to be recaptured. The 2005 Act also permits recapture of fraudulent transfers to trusts within 10 years of the bankruptcy filing.

What it Means for Vendors

Creditors and trustees are given a greater opportunity to recapture assets that were fraudulently transferred, thereby increasing the distribution to vendors.

Rewriting the Involuntary Bankruptcy Petition Law

What is an Involuntary Bankruptcy Petition? (section 303)

The purpose of involuntary bankruptcy is to provide vendors with a means of assuring equal distribution of the debtor's assets. In addition, an involuntary proceeding may benefit vendors (once an order for relief is entered) as a trustee can use the Bankruptcy Code's avoidance powers to recapture fraudulent conveyances, preferential transfers and unseat improperly perfected liens.

Vendor's Debt Must not be Subject to a Bona fide Dispute (section 1234)

A creditor whose claim is subject to a bona fide dispute as to liability or amount may not be a petitioner in an involuntary bankruptcy case.

What it Means for Vendors

Under this provision, a creditor may be disqualified as a petitioning creditor where there is a legitimate basis for the debtor not paying the debt or disputing the amount. The policy for excluding claims subject to a bona fide dispute is to prevent creditors from using involuntary bankruptcy to coerce the debtor to pay debts which the debtor has legitimate defenses. If the court finds there is a bona fide dispute to a claim, the petitioning creditor does not qualify, and the petition must be dismissed, unless another qualified creditor is permitted to join the involuntary petition. To reduce the risk that it may be disqualified as a petitioning creditor, the vendor may consider including language in their credit application that forces the debtor to timely inspect the goods shipped: