Business Law Notes
Spring 2002 Edition
Imagine that your best customer has just filed bankruptcy. It looks like the $25,000 invoice that you just sent to this customer is not going to get paid. It is a blow that staggers your small business. Imagine again that a few weeks later you receive some correspondence related to the bankruptcy demanding that you repay three months worth of collections that you received from your bankrupt customer. Your customer had been way behind on payments and you bent over backwards to keep him afloat; you worked hard to collect all that past due money.
Next, you go to your lawyer who says something about “preferential transfers” and tells you that if you don’t immediately pay all this money into the bankruptcy court, you’re going to be sued for it and you are going to lose.
This nightmare is repeated on a regular basis throughout the country and especially during times of economic downturn.
The federal Bankruptcy Code is designed to prevent a company on the verge of bankruptcy to prevent a company on the verge of bankruptcy from paying its friends and favored customers while other creditors are left empty handed. Basically, if a company pays a past due debt (an “antecedent debt” in bankruptcy terminology) within 90 days prior to its filing a petition for bankruptcy, the bankruptcy trustee can set aside that payment and require the person receiving the payment to pay it back to the bankruptcy court. If you are an “insider, ” for example an officer (even an assistant secretary), director or family member, the 90-day preference period is extended to one year.
The best defense to a preference claim is to ensure that customers pay on time and to put slow paying customers on a COD basis. Other things can be done on a case by case basis to reduce the risk of a “preference” claim. For example, past due debts can usually be restructured so that they fall under the “new value” exception. Also, “earmarking” payments may sometimes work. Competent legal advice is essential to maximize the availability of defenses to a claim by the bankruptcy trustee of a preferential transfer.
Businesses regularly enter into contracts containing a clause requiring arbitration through the American Arbitration Association (AAA). Few people, however, have a clear understanding of the risks and benefits of arbitration. Supporters feel that arbitration is cheaper and faster than the court process. Others find it to be a surprisingly expensive and risky alternative. Here are some of the pros and cons of AAA arbitration and a few basic facts:
- Arbitration provides an opportunity to choose the decision maker. Under AAA’s rules, the AAA administrator provides each party with a list of proposed arbitrators who are generally familiar with the subject matter involved in the dispute. Each side has 10 days to strike any names that are unacceptable and number the remaining names in order of preference. The AAA then picks the arbitrators from the names remaining on the list.
- A panel of three arbitrators is much less likely to “run wild’ than a jury. Arbitration affords an opportunity to choose intelligent, experienced professionals who will see past the red herrings and smoke screens thrown up by the opposition. This is probably the best reason for choosing arbitration. Example: It may be possible for a party to choose a CPA as an arbitrator, especially if there is a panel of three arbitrators. This can be extremely useful if the case involves valuation issues or complicated financial or business issues.
- Arbitration is definitely quicker than the court process. Preliminary issues can typically be decided by a phone conference with the arbitrator. This avoids the sometimes long wait to have preliminary motions set on the court calendar. Time consuming discovery is more limited in arbitration than in court.
- Court rules of evidence do not apply in arbitrations. The arbitrator will generally listen to whatever evidence is presented and will give it whatever weight he thinks appropriate.
- Arbitration is more private than the court process. Unless one side appeals, there will be no public record of the hearing. The parties can agree to have the whole hearing process made confidential if they wish.
- AAA arbitration is not cheap. Filing fees are non-refundable and range from $500 for disputes involving $10,000 or less up to $13,000 for disputes involving $7 to $10 million dollars plus a case service fee of $3,000. A party filing a counterclaim in the same arbitration must also pay a filing fee. There are also hearing fees, postponement fees, processing fees and charges for hearing room rental. The fees for individual arbitrators are comparable to other professionals and are set by the arbitrators themselves. If the arbitrator must travel to the hearing location, the parties must pay for his lodging, travel and related expenses. These costs are generally split equally by both sides of the dispute.
Additional Points to Note.
Early in the arbitration process, a decision must be made as to whether to use a single arbitrator or a panel of three arbitrators. Expenses for a panel of three arbitrators can mount up quickly, especially if there are preliminary hearings in addition to the final hearing. A single arbitrator will be less expensive. However, there will be a substantially greater risk of getting stuck with an unreasonable result.
It is extremely difficult to overturn an arbitrator’s decision. Unless the parties agree otherwise, the typical arbitrator’s award simply states its decision without any explanation. When no explanation is given, the arbitrator’s award is rarely overturned by an appeal.
The opportunity to request documents, ask written questions or conduct depositions of the other side’s witnesses is much more limited in arbitration than in court. This keeps costs down, but it may also make it impossible to get important information from the other side.
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