The Bankruptcy Strategist – Defending Preference Actions
February 1994 – The Bankruptcy Strategist
Don’t Write That Check Yet:
Checklist: Defending Preference Actions
By Karen L. Myers Zauner and Monique D. Almy
From an unsecured creditor’s point of view, one of the most difficult “inequities” arising out of a bankruptcy is the trustee’s or debtor-in-possession’s attempt to undo an alleged preferential transfer. A preferential claim often adds insult to injury for your unsecured creditor client since it’s asking the client to give back payments and increase his or her exposure to the debtor.
Under Bankruptcy Code Sec. 547, a creditor can sometimes be compelled to repay money previously paid to it by the debtor as payment of an existing debt. There are two some what conflicting purposes of Sec. 547:
- promoting equal treatment of claims by similarly situated credits; and
- discouraging credits from racing to the courthouse to obtain a judgment (which encourages preferential payments) by shielding from avoidance certain payments made in the ordinary course of business.
It is the juxtaposition of these two purposes and the resultant limiting and exclusionary provisions of Sec. 547 and interpretive case law that afford your creditor clients certain defenses to a turnover claim. This article provides the framework for your review of Sec. 547 and the development of your client’s defenses.
Elements of a Preference Action
To avoid a payment as a preference, Sec. 547 (b) requires the plaintiff to prove all of the following elements to make a prima facie case that a transfer is avoidable as a preference:
“(1) A transfer (e.g., payment) of (2) an interest of the debtor in property …(3) to a creditor…(4) on account of an antecedent debt owed by the debtor before such transfer was made…(5) while the debtor was insolvent…(6) within ninety days (or within one year as to ‘insiders’) before the date of the filling of the petition…(7) that enables such creditor to receive more than such creditor would receive if this case were a case under Chapter 7…(and) the transfer had not been made.”
If the plaintiff can prove these seven elements, then the burden of proof shifts to your client to prove one of several defenses available under Sec. 547(c).
It is fairly easy for a trustee to prove a payment or other transfer to a creditor on account of an antecedent debt (that is, a debt owed by the debtor at least a second before the payment was made). This is so because “transfer” is broadly defined in Code Sec. 101 (54) as “every mode, direct or indirect, absolute or conditional, voluntary or involuntary, of disposing of or parting with property or with an interest in property, including retention of title as a security interest and foreclosure of the debtor’s right of redemption.”
What constitutes “property” within the meaning of Secs. 541 and 547, is a question of federal law. However, be careful to make certain that they payment was made by the debtor; if the money paid or property transferred was not property of the debtor, the plaintiff will not be able to satisfy that requirement of Sec. 547. The transfer of property in which the debtor holds mere legal title is not enough to satisfy this element. Begier v. IRS, 496 US 53, 110 S. Ct. 2258 (1990).
The plaintiff bears the burden of proof of these elements, except that, under Sec. 547(g), a debtor is presumed to be insolvent during the 90-day period prior to the filing of a bankruptcy proceeding. Secs. 547(f) and (g). Of course this presumption may be overcome by proof of solvency using an accountant, appraisals and financial statements.
You also need to determine the date of the “transfer”. The “transfer” occurs on the date of honor of a check, under the US Supreme Court’s decision in Barnhill v. Johnsons, 112S. Ct. 1386, 118 L.Ed.2d 39(1992), while a judgment becomes a transfer on the date it is docketed. Nelson Co. v. Counsel for the Official Committee of Unsecured Creditors v. Amquip Corp., 959 F.2d 1260 (3d Cir. 1992). For purposes of calculating whether the transfer was made within 90 days, count backwards from the date of the filing of the bankruptcy petition.
The Final Element
The final element of a prima facie case is that, as a result of the transfer, the creditor must have received more than it would have received in a Chapter 7 case and if the transfer had not been made. Evidence of this calculation my be found in a Chapter 11 disclosure statement (expect is to say either little or no distribution to unsecured creditors in Chapter 7 liquidation), a Chapter 11 plan of reorganization (extended payments must be discounted to present value), the debtor’s schedules, the Chapter 7 trustee’s reports, financial statements, asset appraisals and accountants’ testimony. At least one court has stated that, if the bankruptcy estate is unable to provide a 100 percent distribution (the most common occurrence), any unsecured creditor who receives a payment within the preference period is in a position to receive more than it would receive in a Chapter 7 liquidation, thus fulfilling the “more than” requirement. All is not lost, even if the plaintiff can prove all of the elements sets out seven defenses as to which the burden of proof falls on the unsecured creditor under Sec. 547(g).