Preference Litigation ASK LLP
What is a preference? • A preference is a payment made by an insolvent debtor that favors certain creditors over others. • The causes of action to avoid and recover preferential payments are codified in 11 U.S.C. §§ 547(b) and 550(a). 2
Purposes of the Preference Statute • Discourages creditors from racing to the courthouse to dismember the debtor during debtor’s slide into bankruptcy • Facilitates the prime bankruptcy policy of equality of distribution among creditors of the debtor 3
Elements of Section 547(b) A trustee may avoid any transfer of an interest of the debtor in property — • (1) to or for the benefit of a creditor; • (2) for or on account of an antecedent debt owed by the debtor before such transfer was made; • (3) made while the debtor was insolvent; • (4) made — • (A) on or within 90 days before the date of the filing of the petition; or • (B) between ninety days and one year before the date of the filing of the petition, if such creditor at the time of such transfer was an insider; and • (5) that enables such creditor to receive more than such creditor would 4 have received in a Chapter 7 liquidation.
Debtor’s Interest in Property • Defined: Property that would have been part of the estate had it not been transferred before the commencement of bankruptcy proceedings. 1 • Money paid from a commingled bank account under the debtor’s control is presumptively the debtor’s property. 2 • Consignment goods are usually considered to be the debtor’s property. 3 1 Beiger v. I.R.S., 496 U.S. 53 (1990) 5 2 In re Bullion Reserve of N. Am., 836 F.2d 1214 (9th Cir. 1988) 3 In re Andaco, Inc., 226 B.R. 578, 580 (Bankr. W.D.Ky. 1998)
Debtor’s Interest in Property • Available credit is an interest of the debtor in property. 1 • When making a purchase by credit card, both the credit card company and the vendor can be recipients of preferential transfers from a debtor. • The credit card company will be a recipient of a preferential transfer if the debtor makes a payment on its credit card bill. • The vendor will be a recipient of a preferential transfer because the debtor chose to use its available credit to pay that particular vendor instead of distributing the funds among all of the debtor’s creditors. 2 1 In re Marshall, 550 F.3d 1251 (10th Cir. 2008). 6 2 In re Werner, 365 B.R. 283, 284 (Bankr. M.D.Ga. 2007)
No Interest of Debtor In Property • Property held in trust by the debtor for the benefit of another is not property of the estate. However, if trust funds are commingled with other funds, the proponent of the trust has the burden of tracing and identifying the trust funds. 1 • “Earmarked” Property: When a third party loans money to a debtor for the sole purpose of repaying a specific debt to a specific creditor, the money never becomes property of the debtor’s estate. 2 • Example: A bank made a loan to a debtor to satisfy subcontractors' liens on the debtor’s property. The loan was secured by a second mortgage on the debtor’s property. The bank paid the funds directly to the subcontractors. Due to an oversight, the second mortgage was perfected during the preference period. Under these circumstances, the earmarking doctrine protected the second mortgage from avoidance. 3 1 In re Ameripay, LLC, 2012 WL 246397 (Bankr. D.N.J. Jan. 25, 2012) 7 2 McCuskey v. National Bank of Waterloo (In re Bohlen Enters., Ltd.), 859 F.2d 561 (8th Cir. 1988) 3 Kaler v. Community First National Bank ( In re Heitkamp ), 137 F.3d 1087 (8th Cir. 1998)
To or For the Benefit of a Creditor • When a debtor borrows funds from a lender, and subsequently, the lender assigns its right to payment to third party, the debtor’s payment to the third party is for the benefit of a creditor. 1 • When a Ponzi scheme debtor received funds from an investor for the purchase of bullion, the investor became a creditor because he accrued a right to demand bullion from the debtor. Although this right was not mature, it still constituted a claim under the Bankruptcy Code. 2 • Even a buyer of goods from a debtor can become a creditor of the debtor. For example, if a debtor ships non-conforming goods and subsequently refunds the buyer’s payment for those goods, the refund constitutes a payment made to or for the benefit of a creditor. 3 1 In re Cardon Realty Corp., 146 B.R. 72, 79 (Bankr. W.D.N.Y. 1992) 8 2 In re Bullion Reserve of N. Am., 836 F.2d 1214 (9th Cir. 1988) 3 In re Cybermech, Inc., 13 F.3d 818 (4th Cir. 1994)
On Account of an Antecedent Debt • A debt is “antecedent” if it was incurred before the allegedly preferential transfer. 1 • Prepayments cannot be avoided because they are not made on account of an antecedent debt. In other words, there was no debt owed at the time of the payment. 2 1 Jones Truck Lines, Inc. v. Cent. States, S.E. & S.W. Areas Pension Fund (In re Jones Truck Lines, Inc. ), 130 F.3d 323 (8th Cir. 1997) 9 2 In re Rooster, Inc., 127 B.R. 560 (Bankr. E.D.Pa. 1991)
When is the Debt Incurred? GOODS SERVICES • Depending upon the • The debt is incurred parties’ contract terms, on the date that the the debt is incurred on services are the delivery date or the rendered. 2 shipment date. 1 1 In re Furrs Supermarkets, Inc., 296 B.R. 33 (Bankr. D.N.M. 2003) 10 2 In re First Jersey Sec., Inc., 180 F.3d 504 (3d Cir. 1999)
Made When the Debtor is Insolvent • Under 11 U.S.C. § 101(32), insolvent means that the sum of the debtor’s debts is greater than all of the debtor’s property , at a fair valuation. • 11 U.S.C. § 547(f) provides a rebuttable presumption that the debtor was insolvent on or during the 90 days immediately preceding the petition date. 11
90 Day v. 1 Year Preference Period 90 Day Preference Period 1 Year Preference Period • Defendant must be an • Defendant can be anyone insider of the debtor. whose dealings with the debtor are at arm’s length. • Examples: Relatives, general partners, directors, officers, • Plaintiff is entitled to control persons, affiliates, and managers statutory presumption of insolvency. • Plaintiff is not entitled to statutory presumption of insolvency. 12
Creditor Receives More Than It Would Have Received in a Chapter 7 Case • Unless the debtor’s estate has sufficient funds to provide a 100% distribution, any unsecured creditor that received a payment during the preference period received more than it would have received under a Chapter 7 liquidation. 1 • General unsecured creditors cannot return the difference between the preferential payment and the amount that they would have received in a Chapter 7 liquidation because the total amount of their distribution will not be known until the debtor’s bankruptcy case is closed. • Payments to fully secured creditors are not preferential because the creditors would be entitled to full payment in a Chapter 7 liquidation. 2 • Payments to undersecured creditors are preferential to the extent that such payments are applied to the unsecured portions of debt. 3 1 In re Chattanooga Wholesale Antiques, Inc., 930 F.2d 458 (6th Cir. 1991) 13 2 In re Powerine Oil Co., 59 F.3d 969 (9th Cir. 1995) 3 In re El Paso Refinery, L P, 171 F.3d 249 (5th Cir. 1999)
Recovery of Preferential Transfers • Under 11 U.S.C. § 550(a), a trustee can recover a preferential transfer from an initial transferee or an entity for whose benefit such transfer was made. • Factoring Agreement Scenario: Creditor A sells goods to Debtor on account. Subsequently, Creditor A enters into a factoring agreement with Creditor B whereby Creditor A sells or assigns its accounts receivable from Debtor to Creditor B. The trustee may bring a preference action against Creditor B as the initial transferee and Creditor A as the entity for whose benefit such transfer was made. 1 • Mere Conduit Defense: A transfer will not be avoidable if a defendant can establish that: 1) it lacked dominion and control over the transfer because the funds simply passed through its hands; and 2) that it had no power to redirect the funds to its own use. 2 Generally, "mere conduits" are parties who hold transferred funds via escrow, trust, or deposit, and do so only in the status of commercial or professional intermediaries for parties that actually hold or receive a legal right, title, or interest. 3 • Example: A law firm that received funds from a debtor in settlement of a client's lawsuit, and subsequently transferred those funds to its client was a mere conduit for those funds and not an initial transferee. 4 1 In re Connolly N. Am., LLC, 340 B.R. 829 (Bankr. E.D.Mich. 2006) 14 2 In re CVEO Corp., 327 B.R. 210 (Bankr. D.Del. 2005) 3 In re Bauer, 318 B.R. 697 (Bankr. D.Minn. 2005) 4 In re Fabric Buys of Jericho, Inc., 33 B.R. 334 (Bankr. S.D.N.Y. 1983)
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