Which Came First—Debt or Payment?
The bankruptcy trustee must also prove that the
payment was made for a debt that was owed before
the payment was made. Staffing firms can therefore avoid having to return payments by obtaining
payment from the client before providing services to
If your client files for bankruptcy before your
staffing firm provides the services, you may have
to refund the unearned portion of the advance, but
you won’t be paying back your own money.
Defenses Against Preference Claims
Even if a client’s bankruptcy trustee can prove a
preference claim, the staffing firm may still be able
to avoid having to return payment.
Service and payment at the same time. A staffing firm may be able to defend against a preference
claim by establishing that the payment received was
intended to be made as a contemporaneous exchange
for new value provided to the client, and was in fact
a substantially contemporaneous exchange.
Simply put, the staffing firm and client agree that
services and payment will be exchanged at essentially the same time.
To establish this defense, a written agreement
or correspondence confirming the understanding
between the parties would be useful.
In addition, the staffing firm would have to prove
that the payment was actually made “substantially
contemporaneous” with the provision of services.
Since there is no bright-line test, or unambiguous
guideline, in the Bankruptcy Code or in case law
for determining how quickly a payment must be
received to qualify as a contemporaneous exchange,
staffing firms should invoice clients as frequently as
practical, with an express understanding between
the staffing firm and client that payment will be
made on specified terms as close to cash on delivery
Business as usual. Congress has provided another
defense to creditors. This defense is available when
the debt that is paid was “incurred in the ordinary
course of business or financial affairs of the debtor
and the transferee,” and the payment was made
either in the ordinary course of business or “accord-
ing to ordinary business terms.”
It is reasonable to assume that debts incurred for
staffing services are incurred by the client in the
ordinary course of business. The more likely bone
debtor. If so, the trustee cannot prove one of the
necessary elements of a preference claim.
For staffing firms, this issue may arise if a client
uses a vendor management system (VMS) and the
VMS firm bills and collects from clients, keeps its
service fees, and passes the balance on to staffing
firms. If the VMS firm goes bankrupt, as Ensemble Chimes did in 2008, would payments made to
the staffing firms constitute transfers of the VMS
Staffing firms would argue that such payments
never belonged to the VMS firm, and therefore were
not its property. This argument should be successful
if the staffing firm and the VMS firm have clearly
agreed in writing that funds collected by the VMS
firm (with the exception of its service fees) do not
become its property, and if the VMS has segregated
its funds from those collected for the staffing firm in
a trust or escrow account.
For a staffing firm to be required to return
a payment, it must be the beneficiary of the
payment, or the transferee. In most cases, the beneficiary is easy to identify, but not in all cases.
For example, if a staffing firm client goes into
bankruptcy, are payments made by the client to
a VMS firm considered transfers from the client
to the VMS or to staffing firms? The greater the
degree of control over the payments exercised by
the VMS, the more persuasively a staffing firm
could argue that the VMS was the beneficiary.
This is not to suggest that it is a good practice
to permit a VMS to commingle funds paid by
clients with its own funds or to otherwise treat
those funds as its own. However, if a VMS insists
on maintaining significant control over funds
received from clients, a staffing firm may argue
that the VMS should pay the preference claim.
If your client files for bankruptcy before your staffing
firm provides the services, you may have to refund the
unearned portion of the advance, but you won’t be
paying back your own money.