Preference Proofing a Settlement Agreement

Readers of our posts are aware that at Shenwick & Associates we do personal and business bankruptcy filings and workouts for many clients. 

In addition, we review settlement agreements for clients so that the settlement payments are not captured by section 547 of the Bankruptcy Code as a preference (also known as "preference proofing a settlement agreement").   This week we were retained by 2 clients who wanted their settlement agreements reviewed regarding preference exposure.

This work is usually referred to us by the client or the client's litigator. 

There are generally 3 signs that indicate that a defendant may file for bankruptcy protection either after the settlement agreement is signed or after making some or all of the payments required by the settlement agreement. 

1. During settlement negotiations, the defendant discusses filing for bankruptcy.

2. During settlement negotiations, the defendant discusses closing its business or

3. The defendant asks for more than 30 days to make the initial settlement payment. 

In the event that a defendant files for chapter 7 bankruptcy within 90 days of making a payment to the plaintiff,  that payment may be a voidable preference and subject to recapture or clawback by a bankruptcy trustee in a chapter 7 bankruptcy proceeding.

Clients will be extremely upset and point fingers if their settlement payments are clawed back by a bankruptcy trustee or they need to defend a lawsuit (adversary proceeding) by a bankruptcy trustee seeking to recapture those payments.

What can be done to preference proof a settlement payment?

 Below are some suggestions and strategies,  but a risk will always remain until 90 days have passed from the date of payment.

1. Seek financial statements from the defendant or better yet a financial statement under penalty of perjury (an Affidavit of Net Worth), Have your CPA or a bankruptcy attorney review those financial statements.

2. Seek a guarantee of the payments from a 3rd party.

3. Make the plaintiff a secured creditor by receiving a mortgage on real estate or a security agreement and ucc-3 on another asset like accounts receivable. 

4. Structure the settlement agreement so payments are made sooner rather than later.

5. Have the defendant stipulate to a judgment or a confession of judgment and have the plaintiff provide a satisfaction, 90 days after payment is made.

6. Delay providing a release to the defendant until 90 days have passed from payment.

7. Use the “earmarking doctrine” which provides that payments that are supplied by a 3rd party such as a  bank or a malpractice insurer  and earmarked for payment to a creditor are not preferential. 

8. Language should be included in the settlement agreement that preserves the plaintiff’s claim if any settlement payments are recaptured.

9. Finally the settlement agreement should state that if the defendant files for bankruptcy the automatic stay, provided for in section 362 of the bankruptcy code is deemed lifted with respect to the Plaintiff.

Although no single factor may win the day, a plaintiff should attempt to obtain as many of the above points as possible.

Plaintiffs or their counsel having questions about settlement agreements and preferences should contact Jim Shenwick, Esq. 212-541-6224 or jshenwick@gmail.com