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PREFERENTIAL TREATMENT IN BANKRUPTCY
IMPORTANT: THIS FIRM MAKES NO REPRESENTATIONS AS TO THE ACCURACY OR CURRENT STATUS OF ANY LAW, CASE, ARTICLE OR PUBLICATION CITED HEREIN OR LINKED TO. WARNING – SOME OF THESE REFERENCES ARE PRE-BAPCPA.
Video – Breaking Down Bankruptcy: Fraudulent Transfer and Preference Actions
Basic 101 – intended for use by in-house counsel and other non-bankruptcy attorneys.
Pursuant to section 547(b) of the United States Bankruptcy Code, 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 receive if —
(a) the case were a case under chapter 7 of this title;
(b) the transfer had not been made; and
(c) such creditor received payment of such debt to the extent provided by the provisions of this title.
11 U.S.C. § 547(b). It is the plaintiff’s burden to prove each and every one of these elements by a preponderance of the evidence. 11 U.S.C. § 547(g); Danning v. Bozek (In re Bullion Reserve of N. Am.), 836 F.2d 1214 (9th Cir. 1988). Failure to satisfy this burden on any one element precludes a finding that a transfer is a preference. Hood v. Brownyard-Sharon Park Center Inc. (In re Hood), 118 B.R. 417, 421 (Bankr. D.S.C. 1990); Norman v. Jirdon Agri Chemicals, Inc. (In re Cockreham), 84 B.R. 757, 761 (D.Wyo. 1988). Further, because the elements above are objective, the intent of the debtor is irrelevant. Marathon Oil Co. v. Flatau (In re Carig Oil Co.), 785 F.2d 1563 (11th Cir. 1986). Accordingly, it is the effect of the transfer which is controlling. Barash v. Public Fin. Corp., 658 F.2d 504, 510 (7th Cir. 1981).
In re Longview Aluminum, LLC, 10-2780 (7th Cir. 2011), the Seventh Circuit Court of Appeals held that members of an LLC are insiders for preferential transfer purposes under the Bankruptcy Code. Trustee makes demand for return of funds paid within 90 days of Petition.
Some important defenses are:
- Substantially Contemporaneous Exchange. This is a flexible concept calling for a case by case inquiry. For example, one case held that a lien granted in exchange for a loan may be substantially contemporaneous even though the lien was not perfected for 16 days.
- Ordinary Course of Business. This is probably the most useful defense. If the payments are received in the ordinary course of business, the trustee cannot require repayment. Although the term ordinary course of business is not defined in the Bankruptcy Code, case law is reasonably clear as to its meaning. Determination as to ordinary course generally requires an analysis of the credit relationship between the parties for an extended period.
- Subsequent Advance Rule. Another useful defense is the subsequent advance of unsecured credit following receipt of the payment. In situations where there is an ongoing credit relationship, the analysis as to deliveries and application of payments can be quite complicated. Some cases require the subsequent advance to remain unpaid while others do not. The subsequent advance rule applies to both goods and services.
- Small Transfers. In business cases, transfers of an aggregate value of less than $5,475.00 cannot be recovered.
- Delivery of Goods Within 20 Days of Bankruptcy. Unpaid deliveries of goods within 20 days are entitled to payment as administrative (higher priority) claims. Creditors should always assert these claims as soon as they learn of the bankruptcy filing. However, in some cases where that has not been done, it may not be too late to do so toward the end of the case when the preference demand is received.
New Jersey Tax Foreclosures Can Be Preferences
Hackler v. Arianna Holdings Co. (In re Hackler), 18-15650 (3d Cir. Sept. 12, 2019) Unlike mortgage foreclosures, which can be immune from attack in bankruptcy court, a tax foreclosure in New Jersey may be set aside as a preference because the process does not entail a public auction related to the value of the property, the Third Circuit held.
Upholding the bankruptcy and district courts, Circuit Judge Jane R. Roth reasoned that BFP v. Resolution Trust Corp., 511 U.S. 531 (1994), was not controlling. In BFP, the Supreme Court ruled that a regularly conducted mortgage foreclosure sale cannot be avoided as a fraudulent transfer under Section 548.
Whittle Dev. Inc. v. Branch Banking & Trust Co. (In re Whittle Dev. Inc.), Case No. 10-37084-HDH-11, Adv. No. 11-03150 (Bankr. N.D. Tex. July 27, 2011) (docket no. 21). A bankruptcy judge in Dallas recently issued an opinion that exposes foreclosing lenders who credit bid to possible attack. The court in Whittle ruled that a lender that credit bid to purchase its collateral at a foreclosure sale prior to the bankruptcy of the borrower could be sued for a preference to recover the purchased property, even though the debtor could not bring a fraudulent transfer suit regarding the foreclosure sale.
In re Hessco Industries, Inc.9th Cir. BAP 2003 ORDINARY COURSE DEFENSE AGAINST PREFERENCE ACTION REQUIRES EVIDENCE OF PREVAILING BUSINESS STANDARD. Court reverses the bankruptcy court’s conclusion that the ordinary course of business defense precluded judgment for the Trustee on the preference cause of action because appellees had failed to present evidence of prevailing business standards as required under Sulmeyer v. Suzuki (In re Grand Chevrolet, Inc.), 25 F.3d 728, 732 (9th Cir. 1994).
But the court recited with approval remarks from Ganis Credit Corp. v. Anderson (In re Jan Weilert RV, Inc.), 315 F.3d 1192 (9th Cir. 2003), amended by 326 F.3d 1028 (9th Cir. 2003): “[C]reditors are not required to prove a particular uniform set of business terms, rather “ordinary business terms” refers to the broad range of terms that encompasses the practices employed by those debtors and creditors, including terms that are ordinary for those under financial distress. Only a transaction that is so unusual or uncommon “as to render it an aberration in the relevant industry,” falls outside the broad range of terms encompassed by the meaning of “ordinary business terms.”
Ganis Credit Corp. v. Anderson (01/13/03 – No. 01-55455/56872) (9th Cir Ct Apps) Under 11 U.S.C. section 547(c)(2)(C), a court cannot limit “ordinary business terms” to the “average” transactions in the industry, but must consider the broad range of terms that encompasses the practices employed by similarly situated debtors and creditors facing the same or similar problems.
Batlan v. Transamerica Commercial Fin. Corp. (09/13/01 – No. 99-35946) (9th Cir. Ct App) Under 11 USC 547(b)(5), a bankruptcy trustee must still prove that a secured creditor received payments in excess of its secured interest during the 90 days before the debtor filed a petition, even if the creditor had a floating lien.
Matter of Prescott, 805 F.2d 719 (7th Cir. 1986). 7th Circuit has held that the issue with payments on secured debt is whether or not it is fully secured. If debt was fully secured, then the creditor didn’t recover more than it otherwise would have and the trustee can’t satisfy 547(b)(5). But if it is undersecured, then the payment would be avoidable to the extent of the unsecured portion. (of course there may be other defenses, but that’s how the issue regarding secured status plays out).
Frank v. Michigan State Unemployment Agency (06/06/01 – No. 00-1233) (6th Cir St App) Pre-petition liens on the bankruptcy debtor’s property do not reattach to post-petition preference proceeds recovered by a bankruptcy trustee because the proceeds are property of the estate to be distributed to the debtor’s creditors under the Bankruptcy Code.
Morehead v. State Farm Mut. Auto. Ins. Co. (05/03/01 – No. 99-6430) (6th Cir St App) A wage garnishment is an avoidable transfer where the garnishment is of wages earned during the 90-day preference period in bankruptcy under 11 USC 547(b)(4)(A).
Zazzali v. United States (In re DBSI, Inc.), 2017 U.S. App. LEXIS 16817 (9th Cir. Aug. 31, 2017) Avoiding a fraudulent transfer to the Internal Revenue Service (“IRS”) in bankruptcy has become easier, or at least clearer, as a result of a unanimous decision by the Ninth Circuit Court of Appeals.
WHO IS AN INSIDER?
U.S. Bank NA v. The Village at Lakeridge, LLC, 814 F.3d 993, (9th Cir., March 5, 2018)Under the Ninth Circuit’s test, a creditor qualifies as a non-statutory insider if two conditions are met: (1) the closeness of its relationship with the debtor is comparable to that of the enumerated insider classifications in the Bankruptcy Code; and (2) the relevant transaction is negotiated at less than arm’s length.
BOYFRIEND, GIRLFREND or FIANCE’
In re Witt, In Bankruptcy Case No. 06-70503 (Bankr. C.D. Ill. 2/25/2008) (Bankr. C.D. Ill., 2008) In re Witt, In Bankruptcy Case No. 06-70503 (Bankr. C.D. Ill. 2/25/2008) (Bankr. C.D. Ill., 2008)
That court found, inter alia in deciding on a MSJ:
“The Trustee’s failure to set forth the details of the relationship of the Debtor and the Defendant may have been based on the Trustee’s misunderstanding of the law. The Trustee asserts in his argument that there is a per se rule that a “boyfriend” or “girlfriend” is an insider. This is not, however, a correct statement of the law.
An “insider” is defined by the Bankruptcy Code as including “a relative of the debtor or a general partner of the debtor.” 11 U.S.C. § 101(31)(A)(i). “Boyfriends” and “girlfriends” do not fall within that statutory definition. The statutory list is not, however, exhaustive. The Seventh Circuit has stated that, in determining whether a person not specifically included in the statutory definition is an insider, courts should focus on two factors: (i) the closeness of the relationship between the debtor and the transferee, and (ii) whether the transaction between the debtor and the transferee was conducted at arm’s length. In re Krehl, 86 F.3d 737, 742 (7th Cir. 1996). Thus, the inquiry is fact specific and, absent the presentation of undisputed facts about the relationship and the transaction, summary judgment cannot be granted.”
If the friend is not among the enumerated relations in Section 101(31), then the issue is whether the friend is a non-statutory insider. The test in the Ninth Circuit is as stated by Justice Kagan in Village at Lakeside:
“The decisions are not entirely uniform, but many focus, in whole or in part, on whether a person’s ‘transaction of business with the debtor is not at arm’s length.’’ U.S. Bank Nat. Ass’n ex rel. CW Capital Asset Management LLC v. Village at Lakeridge, LLC, 138 S. Ct. 960, 963-64 (quoting 2 A. Resnick & H. Sommer, Collier on Bankruptcy ¶ 101.31, p. 101-142 (16th ed. 2016) and In re U.S. Medical, Inc., 531 F.3d 1272, (10th Cir. 2008)).
“The Ninth Circuit here, as noted earlier, endorsed a two-part test for non-statutory insider status, asking whether the person’s relationship with the debtor was similar to those of listed insiders and whether the relevant prior transaction was at “less than arm’s length.” U.S. Bank Nat. Ass’n ex rel. CW Capital Asset Mgmt. LLC v. Vill. at Lakeridge, LLC, 138 S. Ct. 960, 96 (2018).
The four concurring justices (Justices Sotomayor, Kennedy, Thomas, and Gorsuch), however, raised the issue of whether that is the correct standard.
“First, it could be that the inquiry should focus solely on a comparison between the characteristics of the alleged nonstatutory insider and the enumerated insiders, and if they share sufﬁcient commonalities, the alleged person or entity should be deemed an insider regardless of the apparent arm’s-length nature of any transaction.” U.S. Bank Nat. Ass’n ex rel. CW Capital Asset Management LLC v. Village at Lakeridge, LLC, 138 S. Ct. 960, 971 (2018) (Sotomayor, J, concurring).
Or: “it could be that the test should focus on a broader comparison that includes consideration of the circumstances surrounding any relevant transaction. If a transaction is determined to have been conducted at less-than-arm’s length, it may provide strong evidence in the context of the relationship as a whole that the alleged non-statutory insider should indeed be considered an insider. Relatedly, if the transaction does appear to have been undertaken at arm’s length, that may be evidence, considered together with other aspects of the parties’ relationship, that the alleged non-statutory insider should not, in fact, be deemed an insider.” U.S. Bank Nat. Ass’n ex rel. CW Capital Asset Management LLC v. Village at Lakeridge, LLC, 138 S. Ct. 960, 971-72 (2018) (Sotomayor, J, concurring).
Notes by: Prof. Bruce A. Markell, Northwestern Pritzker School of Law [email protected]
In re Alekson, 2:09-bk-33881-CGC – Debtor repaid friend in full outside 90 day pre-petition period. It is undisputed here that Alekson andButcher were friends; however, friendship alone is not sufficient to establish insider status in absence of evidence that the friend dominated the debtor. See Pfeiffer v.
Reinbold (In re Reinbold), 182 B.R. 244, 246 (Bankr. D.S.D. 1995).
A “friend” or other individual that exerts control over the debtor may be a non-statutory insider. Apart from statutory insiders, an insider can also be someone “who has a sufficiently close relationship with a debtor that his conduct is made subject to closer scrutiny than those dealing at arm’s length with the debtor.” See Miller v. Schuman (In re Schuman), 81 B.R. 583, 586 (B.A.P. 9th Cir. 1987); MCA Fin. Group, Ltd. v. Hewlett-Packard (In re Fourthstage Tech., Inc.), 355 B.R. 155, 159 (Bankr. D. Ariz. 2006). There are many factors that a court will consider.
7/2018 Article in ABI – Current Trends in Proving 547(b)’s Affirmative Elements
Can Your Lien Be Avoided if Only the Debtor Will Benefit? The Courts are Split.
Cullen/Dykman, June 29, 2021 (reprint from firm site)
Michael H. Traison Chicago/NYC – 312.860.4230
Michelle McMahon NYC – 212.510.2296
Amanda Tersigni Garden City – 516.357.3738
The United States Bankruptcy Court for the District of New Mexico added its voice to the split in judicial authority on whether a lien or similar transfer can be avoided under sections 544, 547, 548 and 549 of the Bankruptcy Code where only the debtor itself may benefit from the avoidance. Judge Thuma in his recent decision in U.S. Glove, Inc. v. Jacobs (In re U.S. Glove, Inc.), AP No. 21-1009, 2021 WL 2405399 (Bankr. D. N.M. June 11, 2021), held that notwithstanding the lack of a “benefit to the estate” requirement in section 547 of the Bankruptcy Code, an action to avoid a lien belatedly perfected during the preference period could only proceed if avoidance of the lien would benefit the estate (i.e., creditors) and not just the debtor.
Sections 544, 547, 548 and 549 of the Bankruptcy Code empower the debtor or a trustee in a chapter 11 or chapter 7 bankruptcy, respectively, to sue creditors to avoid certain transfers. The most common type are payments received in the 90 days prior to the bankruptcy filing (or 1 year for insiders), often referred to as the preference period, but the term transfer is broadly defined by the Bankruptcy Code and can include the grant and perfection of liens. Where the transfer is of money or property that must be recovered for the estate, this action will include a claim for recovery of the property transferred pursuant to section 550(a) of the Bankruptcy Code. Section 550(a) contains a limit that property may only be recovered for the benefit of the estate. However, in an action to avoid a lien or the perfection of a lien, as was the case in the U.S. Glove decision, section 550(a) may not be asserted and its limitation of benefit to the estate may not be not applicable. Sections 544, 547, 548 and 549 of the Bankruptcy Code do not explicitly limit their avoiding power to situations that will benefit the estate. As recognized by Judge Thuma, courts are split on whether avoidance actions that do not raise section 550 require that there be some “benefit of the estate/benefit of creditors.”
In U.S. Glove, Inc., the debtor sued the defendant – who was also the debtor’s only allowed unsecured creditor – to avoid a lien that the defendant perfected more than 20 months after the grant of his security interest in the collateral securing his loan to the debtor. Id. at *1-2. The defendant’s delayed perfection was within the preference period and the debtor sued the defendant to avoid the lien pursuant to section 547 of the Bankruptcy Code. Id. The plaintiff filed a motion seeking summary judgment and the defendant objected to the motion on the sole issue of whether the action could proceed without a benefit to unsecured creditors (i.e, the defendant). Id. at *4. The defendant asserted that the avoidance powers of section 547 were inapplicable unless creditors benefit. Id.
Judge Thuma discussed the history of the Bankruptcy Act and the split among the courts regarding whether a “benefit to the estate” requirement is imposed when not explicitly provided for in the statute. Id. at *6-9. In siding with the courts requiring a benefit to the estate, Judge Thuma detailed six bases for his decision:
- Under the Bankruptcy Act, a trustee or debtor in possession had to demonstrate a benefit to the estate before she could use her avoidance powers.
- The language and legislative history of the Bankruptcy Code’s avoidance and recovery sections do not evidence a desire to eliminate the “benefit of the estate” rule developed under the Bankruptcy Act, and the Supreme Court has repeatedly held that a clear indication is required before concluding that Congress intended to depart from the past.
- It makes no sense to have a “benefit of the estate” limitation for some avoidable transfers but not others.
- It seems likely that Congress intended the “benefit of the estate” limitation in section 550 to apply to all avoided transactions, and that Congress simply overlooked the situation in which section 550 need not be pled, like the lien avoidance action at issue.
- Granting a security interest actually is a transfer of property, so section 550 should apply.
- Requiring a benefit to the estate is consistent with the purposes of the Bankruptcy Code and the avoidance action provisions which were intended to create equality of distribution among similarly situated creditors and not to be used to generate windfalls for debtors.
Judge Thuma denied summary judgment and notwithstanding his decision in favor of the defendant on the legal issue, held that evidence and briefing on the legal standard was needed regarding whether avoidance of the lien would benefit the estate. The Court held that, “[w]hether a particular action provides a windfall for the debtor or a benefit for the estate ‘depends on a case-by-case, fact-specific analysis’” and would require evidence. Id. at *9 (citation omitted). The Court noted that cases run the gamut from allowing avoidance so long as there is some benefit, to requiring that all proceeds recovered be paid directly to creditors. Id. See also Rushton v. Hiawatha Coal Co. Inc. (In re C.W. Min. Co.), 477 B.R. 176, 189 (B.A.P. 10th Cir. 2012) (“There is also split of authority concerning how broadly to interpret ‘for the benefit of the estate.’”).
In cases where the benefits of avoidance will not run to the creditors, this decision and the others that precede it provide another basis for creditors to defend avoidance actions in addition to the traditional defenses.
Please note that this is a general overview of developments in the law and does not constitute legal advice. Nothing herein creates an attorney-client relationship between the sender and recipient. If you have questions regarding these provisions, or any other aspect of bankruptcy law, please contact Michael H. Traison at 312.860.4230, Michelle McMahon at 212.510.2296 and/or Amanda Tersigni at 516.357.3738.
Footnotes 11 U.S.C. §101(54).  11 U.S.C. §550(a).  Historically, under the Bankruptcy Act of 1898 (the “Bankruptcy Act”) the avoidance and recovery provisions were contained within the same provision and courts uniformly held that avoidance powers were intended to benefit unsecured creditors and could not be used when the only beneficiary was the debtor. U.S. Glove, 2021 WL 2405399, at *5, citing 11 U.S.C. §§ 67 et seq. (repealed) and In Whiteford Plastics Co. v. Chase Nat’l Bank of New York City, 179 F.2d 582 (2d Cir. 1950).  11 U.S.C. §§544, 547, 548 and 549.  Generally, under section 547, the trustee may avoid any transfer of an interest of the debtor in property to or for the benefit of a creditor, for or on account of an antecedent debt owed by the debtor before the transfer was made, while the debtor was insolvent, within 90 days before the date of the bankruptcy petition or between 90 days and one year before the petition date if the creditor of such transfer was an insider, if it permits the creditor to get more than it would get in chapter 7. Id. at *2. The Court found that defendant more or less conceded the debtor’s prima facie case and focused on its argument that the debtor lacks standing to assert the claim because avoiding defendant’s lien would not benefit creditors. Id. at *1.
The Court concludes that Plaintiff has stated a claim that the Payment was a transfer and that Defendant was the initial transferee.
Conclusion: Pension plan loans are bona fide debts outside of bankruptcy and are recognized as such by the Bankruptcy Code. Similarly, payments on account of pension plan loans are transfers and the plan trustee is the initial transferee. At least, the Court reaches those conclusions for the limited purpose of ruling on the motion to dismiss. The motion will be denied by separate order.
A transfer made by check should be deemed to occur on the date the drawee bank honors it.
Barnhill v. Johnson, 503 US 393, 394–95, 112 S Ct 1386, 1387–88, 118 L Ed 2d 39 (1992) The Supreme Court has answered this question- it’s the date the bank honor’s the check. Here’s some language from the case that you might find helpful:
Under the Bankruptcy Code’s preference avoidance section, 11 U.S.C. § 547, the trustee is permitted to recover, with certain exceptions, transfers of property made by the debtor within 90 days before the date the bankruptcy petition was filed. We granted certiorari to decide whether, in determining if a transfer occurred within the 90-day preference period, a transfer made by check should be deemed to occur on the date the check is presented to the recipient or on the date the drawee bank honors it. We hold that the latter date is determinative.
UCC 3-310(b) implements the general principle that a check is an order to pay, not an actual payment.
Under 3-310, if the check is given in satisfaction of an obligation (here the obligation to pay the judgment connected to the garnishment), liability on the underlying obligation is suspended (not discharged) until the check is either paid or dishonored. Section 3-310(a) provides different rules for cashier’s checks.
Transfer date of ordinary check and a cashier’s check
In re Lee, 179 B.R. 149, 161 (B.A.P. 9th Cir. 1995) “Because of these distinctions between an ordinary check and a cashier’s check, we hold that the relevant date of transfer of a cashier’s check for purposes of § 547(b) is the date of delivery. Since we have already held that the purchaser retains a property interest in the cashier’s check until it is delivered, the bankruptcy court’s conclusion of law was correct that the relevant transfer for purposes of § 547(b) took place on September 25, 1992, the date Hall-Mark received the cashier’s check from Debtor.”