Preference Claims, Clawbacks In Bankruptcy Can Disrupt A Construction Project

• Published date: 27 October 2021
• Subject Matter: Real Estate and Construction, Insolvency/Bankruptcy/Re-structuring, Insolvency/Bankruptcy, Construction & Planning
• Law Firm: Holland & Knight
• Author: Mr James Chivilo, Gregory R. Meeder and Richard A. Bixter Jr.

Highlights

• A bankruptcy filing by a single construction project participant can cause a chain reaction in which payments aren't met, leading to financial distress, impacts to project payment systems and completion schedules, and/or bankruptcy for other participants.
• In addition, the bankruptcy trustee administering the case has the ability to claw back or demand the return of all payments made by the debtor to third parties in a 90-day period prior to the date the debtor's bankruptcy case began. These are often referred to as "preference demands."
• The good news is that there are several defenses that may reduce or completely eliminate liability in connection with preference demands.

Because of the injunction that begins as soon as a debtor files for Chapters 7, 11 or 13 bankruptcy - called the automatic stay - creditors and collection agencies are prevented from seeking payment from the debtor. Therefore, a bankruptcy filing by a single construction project participant can cause a chain reaction, leading to financial distress, impacts to project payment systems and completion schedules, and/or bankruptcy for other participants.

In addition, the bankrupt company (debtor) or a court-appointed trustee (trustee) has the ability to demand the return or "claw back" of all payments made by the debtor to third parties in a 90-day period prior to the date that the debtor's bankruptcy case began. These are often referred to as "preference demands."

Other project participants not involved in the bankruptcy can be understandably upset when they learn about this aspect of bankruptcy law. The bankruptcy filing of a construction project participant will likely lead to payment stoppages and project disruptions, and on top of that, a trustee can seek to claw back partial payments received by other contractors, subcontractors or suppliers from the debtor. These demands often take the form of the letter from the debtor's or trustee's attorney (sometimes years after the bankruptcy was filed) and can be followed by a lawsuit filed in the bankruptcy court if the payment demand is not resolved in the debtor's bankruptcy case.

The good news is that non-bankrupt project participants have several defenses that may reduce or completely eliminate liability in connection with preference demands. Many of these defenses are available to all payment recipients, and there are particular defenses that specifically apply to project participants given the contractual relationships among these parties. Below is a discussion of strategies on how project participants are able to address preference demands that are often overlooked in these disputes.

Preference Claims

Preference claims have become a...